-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, K0RzEjo2U3ZnEd+XTI1itfHMOuGENTT5TR7SHl7ArfCz7X9cKycr21r0GfurEFTX ccB3yx5RaR4Vx/ldwN3j1A== 0000811671-97-000010.txt : 19970327 0000811671-97-000010.hdr.sgml : 19970327 ACCESSION NUMBER: 0000811671-97-000010 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 2 CONFORMED PERIOD OF REPORT: 19961231 FILED AS OF DATE: 19970326 SROS: NONE FILER: COMPANY DATA: COMPANY CONFORMED NAME: STERLING FINANCIAL CORP /PA/ CENTRAL INDEX KEY: 0000811671 STANDARD INDUSTRIAL CLASSIFICATION: NATIONAL COMMERCIAL BANKS [6021] IRS NUMBER: 232449551 STATE OF INCORPORATION: PA FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K SEC ACT: 1934 Act SEC FILE NUMBER: 000-16276 FILM NUMBER: 97563546 BUSINESS ADDRESS: STREET 1: NORTH POINTE BANKING CORP STREET 2: 101 NORTH POINTE BLVD CITY: LANCASTER STATE: PA ZIP: 17605-4133 BUSINESS PHONE: 7175816005 10-K 1 UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-K (Mark One) X ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the fiscal year ended December 31, 1996 OR TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from _______ to _______ Commission file number 0-16276 STERLING FINANCIAL CORPORATION (Exact name of registrant as specified in its charter) Pennsylvania 23-2449551 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 101 North Pointe Boulevard Lancaster, Pennsylvania 17601-4133 (Address of principal executive offices) (Zip Code) Registrant's telephone number, including area code: (717) 581-6030 Securities registered pursuant to Section 12(b) of the Act: None Securities registered pursuant to Section 12(g) of the Act: Common Stock, Par Value $5.00 Per Share (Title of class) Indicate by a check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of the Registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. |X| Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X No The aggregate market value of the voting stock held by non-affiliates of the Registrant at February 28, 1997 was approximately $120,131,630. The number of shares of Registrant's Common Stock outstanding on February 28, 1997 was 6,224,830. Documents Incorporated by Reference Portions of the Proxy Statement for the Registrant's 1997 Annual Meeting of Shareholders are incorporated by reference into Part III of this report. Sterling Financial Corporation Table of Contents Page Part I Item 1. Business............................................. 3 Item 2. Properties........................................... 5 Item 3. Legal Proceedings.................................... 6 Item 4. Submission of Matters to a Vote of Security Holders.. 6 Part II Item 5. Market for the Registrant's Common Equity and Related Stockholder Matters.......................... 7 Item 6. Selected Financial Data.............................. 8 Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations.................. 9 Item 8. Financial Statements and Supplementary Data.......... 32 Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure.................. 64 Part III Item 10. Directors and Executive Officers of the Registrant... 64 Item 11. Executive Compensation............................... 64 Item 12. Security Ownership of Certain Beneficial Owners and Management........................................... 64 Item 13. Certain Relationships and Related Transactions....... 64 Part IV Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K.......................................... 65 Signatures...................................................... 67 PART I Item 1 - Business Sterling Financial Corporation Sterling Financial Corporation (the "Corporation") is a Pennsylvania business corporation, based in Lancaster, Pennsylvania. The Corporation was organized on February 23, 1987 and became a bank holding company through the acquisition on June 30, 1987 of all the outstanding stock of The First National Bank of Lancaster County, now by change of name, Bank of Lancaster County, N.A. In addition, the Corporation also owns all of the outstanding stock of a non-bank subsidiary, Sterling Mortgage Services, Inc., a mortgage service company formed by the Corporation as a wholly owned subsidiary that presently is considered inactive. The Corporation provides a wide variety of commercial banking and trust services through its wholly owned subsidiary, Bank of Lancaster County, N.A. (the "Bank"). A major source of operating funds for the Corporation is dividends provided by the Bank. The Corporation's expenses consist principally of operating expenses. Dividends paid to stockholders are, in part, obtained by the Corporation from dividends declared and paid to it by the Bank. As a bank holding company, the Corporation is registered with the Federal Reserve Board in accordance with the requirements of the Federal Bank Holding Company Act and is subject to regulation by the Federal Reserve Board and by the Pennsylvania Department of Banking. Bank of Lancaster County The Bank is a full service commercial bank operating under charter from the Comptroller of the Currency. On July 29, 1863, authorization was given by the Comptroller of the Currency to The First National Bank of Strasburg to commence the business of banking. On September 1, 1980, the name was changed to The First National Bank of Lancaster County and at the time of the holding company reorganization on June 30, 1987, the name was changed to its present name, Bank of Lancaster County, N.A. At December 31, 1996, the Bank had total assets of $763,966,000 and total deposits of $648,205,000. The main office of the Bank is located at 1 East Main Street, Strasburg, Pennsylvania. In addition to its main office, the Bank had twenty-seven (27) branches in Lancaster County and one (1) branch in Chester County, Pennsylvania in operation at December 31, 1996. The Bank provides a full range of banking services. These include demand, savings and time deposit services, NOW (Negotiable Order of Withdrawal) accounts, money market accounts, safe deposit boxes, VISA credit card, and a full spectrum of personal and commercial lending activities. The Bank maintains correspondent relationships with major banks in New York City and Philadelphia. Through these correspondent relationships, the Bank can offer a variety of collection and international services. With the installation of three automated teller machines (ATMs) in April of 1983, the Bank was the first financial institution in Lancaster County to join the MAC (Money Access Center) Network. The Bank now has 17 ATMs in Lancaster County. The Bank became a participating member of the Plus System in the Fall of 1984. This membership entitles the Bank's MAC/Plus cardholders to have access to a nationwide network of over 119,000 ATMs. The Bank introduced Discount Brokerage Service in July, 1983. This service is offered in coordination with TradeStar Investments, Inc., an affiliate of BHC Securities, Inc. and meets the needs of the commission-conscious investor. In 1992 the Bank began offering mutual funds to customers. We believe these services are important additions to our product line and make a statement about our progressive attitude in providing financial services for the future. The Bank was given permission to open a Trust Department by the Comptroller of the Currency on May 10, 1971. The Trust Department provides personal and corporate trust services. These include estate planning, administration of estates and the management of living and testamentary trusts and investment management services. Other services available are pension and profit sharing trusts and self-employed retirement trusts. Trust Department assets totaled over $273 million at December 31, 1996. On January 31, 1983, the Bank purchased Town & Country, Inc. which is a vehicle and equipment leasing company operating in Pennsylvania and other states. Its principal office is located at 1097 Commercial Avenue, East Petersburg, PA. Town & Country, Inc. employs thirty eight (38) people. The Bank's principal market area is Lancaster County. Lancaster County is the sixth largest county in Pennsylvania, in terms of population, behind Philadelphia, Allegheny, Montgomery, Delaware and Bucks. Lancaster County, with an area of 949 square miles has a population of approximately 448,000 people. Lancaster's tradition of economic stability has continued, with agriculture, industry and tourism all contributing to the overall strength of the economy. Lancaster County has one of the strongest and most stable economies in the state. No single sector dominates the county economy. One of the best agricultural areas in the nation, Lancaster County ranks first among Pennsylvania counties and one of the top 20 farm markets in the country. Lancaster County is also one of the leading industrial areas in the state. The county is considered a prime location for manufacturing, away from congested areas, yet close to major east coast markets. Diversification of industry helps to maintain the economic stability of the county. The unemployment rate of the county in December 1996 was 2.8% which was lower than the statewide rate (4.9%) and national (5.3%) level. Lancaster County, with its many historic sites, well-kept farmlands and the large Amish community has become very attractive to tourists and is one of the top tourist attractions in the U.S. The Bank is subject to intense competition in all respects and areas of its business from banks and other financial institutions, including savings and loan associations, finance companies, credit unions and other providers of financial services. There are 14 full-service commercial banks with offices in Lancaster County with some of these banks having branches located throughout Lancaster County and beyond. The institutions range in asset size from approximately $203 million to over $57 billion. Four (4) banks in our trade area exceed $5 billion in assets. Several banks are part of bank holding companies. One bank is part of a bank holding company that has assets in excess of $73 billion while another bank is part of a bank holding company that has over $45 billion in assets. Due to our location, we are in direct competition with the larger banks as well as a number of smaller banks. As of December 31, 1996, the Bank ranked, as measured by total deposits, as the fourth largest in market share within Lancaster County of the banks doing business in Lancaster County. The Bank is not, however, the fourth largest bank in Lancaster County. As of December 31, 1996, the Bank had total assets of over $763 million and ranked ninth on this basis among the commercial banks with offices located in Lancaster County. There has not been a material portion of the Bank's deposits obtained from a single person or a few persons, including federal, state or local governments and agencies thereunder and the loss of any single or any few customers would not have a materially adverse effect on the business of the bank. The Bank has no significant foreign sources or applications of funds. As of December 31, 1996, there were 422 persons employed by the Bank, of which 319 were full-time and 103 were part-time. These figures do not include employees of Town & Country, Inc. which employed 38 persons. The Bank is subject to regulation and periodic examination by the Comptroller of the Currency. Its deposits are insured by the Federal Deposit Insurance Corporation, as provided by law. Item 2 - Properties The Bank, in addition to its main office, had, at December 31, 1996, a branch network of 28 offices and 2 off-site electronic MAC/ATM installations. All branches are located in Lancaster County with the exception of one office which is located in Chester County. Branches at fifteen (15) locations are occupied under leases and at three branches, the Bank owns the building, but leases the land. One off-site MAC/ATM installation is occupied under lease. All other properties were owned in fee. All real estate and buildings owned by the Bank are free and clear of encumbrances. The Corporation owns no real estate. The leases referred to above expire intermittently over the years through 2022 and most are subject to one or more renewal options. Aggregate annual rentals for real estate paid during 1996 did not exceed three percent of the Bank's operating expenses. On December 4, 1996, the Bank purchased a property located at 1097 Commercial Avenue, East Petersburg, PA, situated on 12.7 acres with a building containing approximately 123,000 square feet. The building is used to house the Bank's Administrative Service Center as well as other departments of the Bank. Town & Country, Inc., a wholly owned subsidiary of the Bank, also occupies this building. The building is owned in fee by the Bank, free and clear of encumbrances. The building which previously housed the Administrative Service Center was sold and settlement took place on February 21, 1997. The building formerly occupied by Town & Country, Inc. is under agreement of sale and settlement should take place on or before April 1, 1997. The Bank completed construction of a new headquarters building in 1995 which includes a branch banking office and also serves as headquarters for Sterling Financial Corporation. Occupancy took place in July of 1995. The three-story building contains approximately 53,000 square feet. The Bank and the Corporation occupy approximately 43,000 square feet while nearly 10,000 square feet has been leased to other tenants. The building is owned in fee by the Bank, free and clear of encumbrances. Item 3 - Legal Proceedings As of December 31, 1996, there were no material pending legal proceedings, other than ordinary routine litigation incidental to the business, to which the Corporation or its subsidiaries are a party or by which any of their property is the subject. Item 4 - Submission of Matters to a Vote of Security Holders There were no matters submitted to a vote of security holders during the fourth quarter of 1996. PART II Item 5 - Market for the Registrant's Common Equity and Related Stockholder Matters The common stock of the Corporation is not actively traded. There are 35,000,000 shares of common stock authorized and the total number of shares outstanding as of December 31, 1996 was 6,220,078. As of December 31, 1996, the Corporation had approximately 2,915 holders of record of its common stock. There is no other class of common stock authorized or outstanding. During 1996, the price range of the common stock known by management to have traded was $23.875 to $28.25 per share. A regular $.15 per share dividend, as well as a $.25 per share "Special Dividend", was declared in the second quarter of 1995 and is reflected in the table below. The Corporation is restricted as to the amount of dividends that it can pay holders of its common stock by virtue of the restrictions on the Bank's ability to pay dividends to the Corporation. See Note 18 to the 1996 Consolidated Financial Statements elsewhere herein. The Corporation paid a 5% stock dividend in July 1996. The following table reflects the bid and asked prices reported for the common stock at the end of the period indicated and the cash dividends declared on the common stock for the periods indicated. All information has been retroactively restated to give effect to the 5% stock dividend in 1996. In the absence of an active market, these prices may not reflect the actual market value of the Corporation's stock for the periods reported. 1996 Bid Ask Dividend First Quarter $25.18 $26.13 $.18 Second Quarter 26.36 26.60 .18 Third Quarter 26.25 26.75 .19 Fourth Quarter 25.25 26.25 .19 1995 Bid Ask Dividend First Quarter $27.55 $28.74 $.15 Second Quarter 28.03 28.98 .40 Third Quarter 27.79 28.50 .17 Fourth Quarter 27.31 28.50 .17 The prices used in the previous table represent bid and asked prices furnishe by F.J. Morrissey & Company; Hopper Soliday & Co., Inc.; Legg Mason Wood Walker, Inc.; Prudential Securities; Ryan, Beck & Company; or The National Quotation Bureau. These quotations reflect inter-dealer prices, without retail markup, markdown or commission. The Corporation maintains a Dividend Reinvestment and Stock Purchase Plan for eligible shareholders who elect to participate in the plan. A copy of the Prospectus for this plan can be obtained by writing to: Bank of Lancaster County, N.A. Dividend Reinvestment and Stock Purchase Plan, 101 North Pointe Boulevard, Lancaster, Pennsylvania 17601-4133. Item 6 - Selected Financial Data The following selected financial data should be read in conjunction with the Corporation's consolidated financial statements and the accompanying notes presented elsewhere herein.
Summary of Operations (Dollars in thousands, except per share data) Years Ended 1996 1995 1994 1993 1992 Interest income.............$ 52,558 $ 48,850 $ 41,931 $ 40,092 $ 40,284 Interest expense............ 22,823 21,153 14,926 15,042 17,818 ------ ------ ------ ------ ------ Net interest income......... 29,735 27,697 27,005 25,050 22,466 Provision for loan losses... 580 534 1,081 2,430 2,296 ------ ------ ------ ------ ------ Net interest income after provision for loan losses.. 29,155 27,163 25,924 22,620 20,170 Other income................ 10,572 8,293 7,043 8,979 7,926 Other expenses.............. 26,769 23,423 22,053 21,048 18,922 ------ ------ ------ ------ ------ Income before income taxes.. 12,958 12,033 10,914 10,551 9,174 Applicable income taxes..... 3,147 3,039 2,637 2,749 2,331 ------ ------ ------ ------ ------ NET INCOME..................$ 9,811 $ 8,994 $ 8,277 $ 7,802 $ 6,843 ====== ====== ====== ====== ====== Per Common Share:* Net income..................$ 1.57 $ 1.45 $ 1.35 $ 1.30 $ 1.15 Cash dividends declared**. .74 .89 .58 .54 .48 Book value................ 11.12 10.79 9.76 8.58 7.56 Book value (excluding SFAS 115)............... 10.86 10.51 9.69 8.58 7.56 Average shares outstanding 6,235,257 6,204,212 6,128,058 6,013,937 5,916,198 Ratios: Return on average assets.. 1.34% 1.36% 1.38% 1.41% 1.34% Return on average equity.. 15.01% 15.02% 15.47% 16.90% 16.99% Financial Condition at Year-End: Assets.................... $ 764,072 $ 711,154 $ 633,395 $ 587,883 $ 544,404 Loans (net of unearned)... 473,832 426,312 392,649 359,365 348,529 Deposits.................. 647,036 610,105 537,002 505,680 473,184 Stockholders' Equity***... 69,179 63,909 57,285 49,467 42,794 Average Assets............ 732,226 659,335 600,263 555,216 510,439
*Figures prior to 1996 were retroactively restated for various stock dividends, a three-for-two stock split on November 30, 1992, a two-for-one stock split on September 1, 1994 and for comparative purposes. **The dividend in 1995 includes a $.25 per share "Special Dividend" which was declared in the second quarter of 1995. ***Stockholders' Equity prior to 1993 has been restated for the retroactive effect of SFAS No. 109. Item 7 - Management's Discussion and Analysis of Financial Condition and Results of Operations The following discussion provides management's analysis of the consolidated financial condition and results of operations of Sterling Financial Corporation (the "Corporation") and subsidiaries, Bank of Lancaster County, N.A. (the "Bank") and its subsidiary, Town & Country, Inc. and Sterling Mortgage Services, Inc. (presently inactive). It should be read in conjunction with the audited financial statements and footnotes appearing elsewhere in this report. (All dollar amounts presented in the tables are in thousands, except per share data.) Results of Operations Summary Net income for 1996 was $9,811,000, an increase of $817,000 or 9.1% over the $8,994,000 earned in 1995. The results of 1995 were $717,000 or 8.7% higher than the $8,277,000 reported in 1994. Earnings per share on net income amounted to $1.57, $1.45, and $1.35 for the years ended 1996, 1995 and 1994 respectively. Earnings per share were computed by dividing net income by the weighted average number of shares of common stock outstanding which were 6,235,257, 6,204,212 and 6,128,058 for 1996, 1995 and 1994 respectively. Figures prior to 1996 were retroactively restated to reflect a 5% stock dividend paid in July 1996 and a two-for-one stock split in the form of a 100% stock dividend paid in 1994. Return on average total assets was 1.34% in 1996 compared to 1.36% in 1995 and 1.38% in 1994. Return on average stockholders' equity was 15.01% in 1996 compared to 15.02% in 1995 and 15.47% in 1994. Growth in earning assets was the primary factor contributing to the increased earnings in 1996, while in 1995, both volume and an increase in rates contributed to increased earnings. As of December 31, 1996, earning assets were approximately $673 million compared to $629 million at December 31, 1995 and $563 million at December 31, 1994. Average earning assets for 1996 increased nearly $61 million to approximately $648 million, up 10.3% from the prior year. Similarly, in 1995 average earning assets increased approximately $49 million, up 9.1% from 1994. The current year increase was primarily due to an increase in loans while in 1995 it was primarily due to increases in both loans and investments. Average interest-bearing liabilities increased nearly $59 million or 11.3% in 1996 compared to an increase of nearly $48 million, or 10.2% in 1995. The increase in average earning assets exceeded the increase in average interest-bearing liabilities in both 1996 and 1995. Provision for loan losses increased to $580,000 in 1996 from $534,000 in 1995. The provision in 1994 was $1,081,000. Non-interest income increased $2,279,000 in 1996. This compares to an increase of $1,250,000 in 1995. In 1996, all categories of non-interest income reflected increases over the previous year. Non-interest expenses increased $3,346,000 or 14.3% in 1996 compared to an increase of $1,370,000 or 6.2% in 1995 over 1994. The majority of assets and liabilities of a financial institution are monetary in nature and, therefore, differ greatly from most commercial and industrial companies that have significant investments in fixed assets or inventories. However, inflation does have an important impact on the growth of total assets and on non-interest expenses, which tend to rise during periods of general inflation. The level of inflation over the last few years has been declining. The Federal Deposit Insurance Corporation Improvement Act of 1991 (the "Act") addresses the recapitalization of the bank insurance fund and is designed to limit risk within the banking industry. On August 8, 1995, the Federal Deposit Insurance Corporation (the "FDIC") Board of Directors voted to significantly reduce the deposit premiums paid by most Bank Insurance Fund (the "BIF")-insured institutions to an average of approximately 4.4 cents per $100 of domestic deposits once the FDIC confirmed that the BIF met a reserve ratio of 1.25%. The FDIC determined that the BIF was fully recapitalized at the end of May 1995. As a result, the Bank received a refund in 1995 in an amount equal to insurance overpayments for the months June through September. Under the new assessment rate schedule for the BIF, the Bank's annual rate went to 4 cents per $100 of assessable deposits, down from the then current rate of 23 cents per $100. On November 14, 1995, the FDIC Board of Directors voted to reduce the insurance premiums paid on deposits covered by the BIF, effective for the first semiannual assessment period of 1996. Under the new rate structure for the BIF, assessment rates were lowered by 4 cents per $100 of assessable deposits for all risk categories, subject to the statutory requirement that all institutions pay at least $2,000 annually for FDIC insurance. Since the Bank was included in the lowest premium paying category, the Bank anticipated paying the statutory annual minimum of $2,000 in 1996. However, the Deposit Insurance Funds Act of 1996 eliminated the minimum assessment, resulting in a $500 refund (representing the minimum assessment for the fourth quarter of 1996). As a result of the above FDIC action, the Bank experienced a reduction of the FDIC assessment in 1996 over 1995 as well as a reduction in 1995 over 1994. On September 30, 1996, the President signed into law the Deposit Insurance Funds Act of 1996 to recapitalize the Savings Association Insurance Fund ("SAIF") administered by the Federal Deposit Insurance Corporation ("FDIC") and to provide for repayment of the FICO (Financial Institution Collateral Obligation) bonds issued by the United States Treasury Department. The FDIC will levy a one-time special assessment on SAIF deposits equal to 65.7 cents per $100 of the SAIF-assessable deposit base as of March 31, 1995. During the years 1997, 1998 and 1999, the Bank Insurance Fund ("BIF") will pay $322 million of FICO debt service, and SAIF will pay $458 million. During 1997, 1998 and 1999, the average regular annual deposit insurance assessment is estimated to be about 1.29 cents per $100 of deposits for BIF deposits and 6.44 cents per $100 of deposits for SAIF deposits. Individual institution's assessments will continue to vary according to their capital and management ratings. As always, the FDIC will be able to raise the assessments as necessary to maintain the funds at their target capital ratios provided by law. After 1999, BIF and SAIF will share the FICO costs equally. Under current estimates, BIF and SAIF assessment bases would each be assessed at the rate of approximately 2.43 cents per $100 of deposits. The FICO bonds will mature in 2018-2019, ending the interest payment obligation. The law provides that BIF and SAIF are to merge to form the Deposit Insurance Fund ("DIF") at the beginning of 1999, provided that there are no SAIF institutions in existence at that time. Merger of the Funds will require state laws to be amended in those states authorizing savings associations to eliminate that authorization. This provision reflects Congress's apparent intent to merge thrift and commercial bank charters by January 1999; however, no law has yet been enacted to achieve that purpose. Based on current deposit levels, management expects that the increase in the FDIC assessment rate will adversely impact results of operations in an amount estimated at $82,000 for 1997. The passage of the Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994 and the Riegle Community Development and Regulatory Improvement Act may have a significant impact upon the Corporation. The key provisions pertain to interstate banking and interstate branching as well as a reduction in the regulatory burden on the banking industry. Since September 1995, bank holding companies may acquire banks in other states without regard to state law. In addition, banks can merge with other banks in another state beginning in June 1997. States may adopt laws preventing interstate branching but, if so, no out- of-state bank can establish a branch in such state and no bank in such state may branch outside the state. Pennsylvania recently amended the provisions of its Banking Code to authorize full interstate banking and branching under Pennsylvania law and to facilitate the operations of interstate banks in Pennsylvania. As a result of legal and industry changes, management predicts that consolidation will continue as the financial services industry strives for greater cost efficiencies and market share. Management believes that such consolidation may enhance its competitive position as a community bank. There are numerous proposals before Congress to modify the financial services industry and the way commercial banks operate. However, it is difficult to determine at this time what effect such provisions may have until they are enacted into law. Except as specifically described above, management believes that the effect of the provisions of the aforementioned legislation on the liquidity, capital resources and results of operations of the Corporation will be immaterial. Management is not aware of any other current specific recommendations by regulatory authorities or proposed legislation, which if they were implemented, would have a material adverse effect upon the liquidity, capital resources or results of operations, although the general cost of compliance with numerous and multiple federal and state laws and regulations does have and in the future may have a negative impact on the Corporation's results of operations. Aside from those matters described above, management does not believe that there are any trends or uncertainties which would have a material impact on future operating results, liquidity or capital resources nor is it aware of any current recommendations by the regulatory authorities which if they were to be implemented would have such an effect. Net Interest Income The primary component of the Corporation's net earnings is net interest income, which is the difference between interest and fees earned on interest- earning assets and interest paid on deposits and borrowed funds. For presentation and analytical purposes, net interest income is adjusted to a taxable equivalent basis. For purposes of calculating yields on tax-exempt interest income, the taxable equivalent adjustment equates tax-exempt interest rates to taxable interest rates as noted in Table 1. Adjustments are made using a statutory federal tax rate of 34% for 1996, 1995 and 1994. Table 1 presents average balances, taxable equivalent interest income and expense and the yields earned or paid on these assets and liabilities. The increase in net interest income during 1996 resulted from increased volumes in average earning assets. The increases in net interest income during 1995 was due primarily to increased volumes and interest rates in average earning assets. Average earning assets increased 10.3% in 1996 and 9.1% in 1995. These increases were primarily funded with interest-bearing liabilities which increased 11.3% in 1996 and 10.2% in 1995. Table 1 - Distribution of Assets, Liabilities and Stockholders' Equity Interest Rates and Interest Differential-Tax Equivalent Yields (Unaudited)
Years ended December 31, 1996 1995 1994 Average Annual Average Annual Average Annual Balance Interest Rate Balance Interest Rate Balance Interest Rate Assets: Interest bearing deposits with banks..............$ 103 $ 6 5.72% $ 30 $ 2 6.78% $ 55 $ 2 3.79% Federal Funds sold......... 7,376 398 5.39% 7,583 449 5.92% 6,247 264 4.24% Investment securities: U.S. Treasury securities. 28,789 1,686 5.86% 28,696 1,675 5.84% 26,560 1,471 5.54% U.S. Government agencies. 33,895 2,192 6.47% 27,999 1,761 6.29% 23,353 1,395 5.97% State and Municipal securities.............. 57,966 4,615 7.96% 48,884 4,083 8.35% 44,442 3,781 8.51% Other securities......... 57,189 3,535 6.18% 66,990 4,294 6.41% 62,476 3,961 6.34% ------- ------- ------ -------- ------- ------ -------- ------- ----- Total investment securities177,839 12,028 6.76% 172,569 11,813 6.85% 156,831 10,608 6.76% Loans: Commercial...............245,018 22,276 9.09% 226,032 21,284 9.42% 207,844 17,743 8.54% Consumer.................130,044 11,401 8.77% 106,171 9,766 9.20% 103,572 8,861 8.56% Mortgages................ 41,046 3,330 8.11% 32,739 2,771 8.46% 26,704 2,274 8.51% Leases................... 46,420 4,865 10.48% 41,974 4,350 10.36% 36,802 3,667 9.96% ------- ------- ------ -------- ------- ------ -------- ------- ----- Total loans................462,528 41,872 9.05% 406,916 38,171 9.38% 374,922 32,545 8.68% ------- ------- ------ -------- ------- ------ -------- ------- ----- Total earning assets.......647,846 54,304 8.38% 587,098 50,435 8.59% 538,055 43,419 8.07% Allowance for loan losses.. (7,863) (7,155) (7,472) Cash and due from banks.... 30,238 27,763 27,746 Other non-earning assets... 62,005 51,629 41,934 ------- -------- -------- Total non-earning assets... 84,380 72,237 62,208 ------- -------- ------ -------- -------- ------ -------- -------- ----- Total assets..............$732,226 $ 54,304 7.42% $659,335 $ 50,435 7.65% 600,263 $ 43,419 7.23% ======== ======== ====== ======== ======== ====== ======== ======= ====== Liabilities and Stockholders' Equity: Deposits: Demand deposits Noninterest-bearing....$ 72,052 $ 0 0.00% $ 66,133 $ 0 0.00% $64,446 $ 0 0.00% Demand deposits Interest-bearing........257,622 6,726 2.61% 239,036 7,181 3.00% 229,693 5,375 2.34% Savings deposits......... 58,232 1,288 2.21% 54,982 1,333 2.42% 58,864 1,324 2.25% Time deposits............229,835 12,695 5.52% 194,512 10,579 5.44% 158,994 6,884 4.33% ------- -------- ------ -------- ------- ------ -------- ------- ----- Total deposits.............617,741 20,709 3.35% 554,663 19,093 3.44% 511,997 13,583 2.65% Other borrowed funds....... 30,578 2,114 6.91% 29,143 2,060 7.07% 22,144 1,343 6.06% Other liabilities.......... 17,122 14,856 12,227 Stockholders' equity....... 66,785 60,673 53,895 ------- -------- ------ -------- ------- ------ -------- ------- ----- Total liabilities and Stockholders' equity....$732,226 $ 22,823 3.12% $659,335 $ 21,153 3.21% $600,263 $ 14,926 2.49% ======== ======== ====== ======== ======== ====== ======== ======== ===== Net interest income/ Average total assets...... $ 31,481 4.30% $ 29,282 4.44% $ 28,493 4.75% Net interest income/ Average earning assets.... $ 31,481 4.86% $ 29,282 4.99% $ 28,493 5.30%
Net interest income on a fully taxable equivalent basis increased by $2,199,000 in 1996 compared to an increase of $789,000 in 1995. Table 2 indicates that of the increase in 1996, $2,910,000 was the result of increased volumes. This figure was reduced by $711,000 as a result of decreases in interest rates. The decrease in interest rates had more of an effect on interest paid on earning assets than on interest-bearing liabilities. The increase in 1995 resulted in $1,803,000 from increased volumes while a reduction of $1,014,000 was realized from increases in interest rates. For the year 1996 compared to 1995, loan volumes, on average, increased nearly $56 million and income earned on loans increased $3,701,000, tax adjusted. This compares to a volume increase of nearly $32 million in 1995 over 1994 with an increase in income earned on loans amounting to $5,626,600. As a result of increased volumes in 1996, nearly $5.2 million contributed to the increase in income on loans. Rates charged on loans decreased in late 1995 and into 1996. The decrease in rates reduced interest over $1.5 million in income earned on loans. Increased volumes in loans in 1995 contributed over $2.8 million to the increase in income while $2.8 million was realized due to increases in interest rates. Total investment securities, on average, increased over $5.2 million in 1996 over 1995 compared to an increase of over $15.7 million in 1995 over 1994. The increased volumes in both periods were primarily responsible for the increase in interest income on securities. Table 2 indicates that of the increase in interest income in 1996, $361,000 was the result of increased volumes while a $146,000 reduction resulted from a decrease in interest rates. Increased volumes in securities in 1995 contributed nearly $1.1 million to the increase while $141,000 was generated from an increase in rates. Interest-bearing deposits, on average, grew over $57 million in 1996. The major portion of the increase in interest expense on deposits was generated on time deposits as a result of increased volumes and rates paid for these deposits. Although there were increased volumes on the other deposits, the decrease in rates paid on these deposits reduced the total interest expense by $500,000. In addition to an increase in interest expense due to volumes, interest expense increased due to increases in rates paid on these deposits in 1995. The asssumption of certain deposit liabilities as a result of the acquisition of two retail banking offices from CoreStates on December 1, 1995 added over $20 million in interest-bearing deposits at that particular time. Table 2 - Analysis of Changes in Net Interest Income The rate-volume variance analysis set forth in the table below, which is computed on a tax equivalent basis, analyses changes in net interest income for the periods indicated by their rate and volume components.
1996 Versus 1995 1995 Versus 1994 Increase (Decrease) Increase (Decrease) Due to Changes in Due to Changes in Volume Rate Total Volume Rate Total Interest Income Interest on deposits with banks...........$ 5 $ (1) $ 4 $ (1) $ 1 $ 0 Interest on federal funds sold........... (12) (39) (51) 57 128 185 Interest on investment securities........... 361 (146) 215 1,064 141 1,205 Interest and fees on loans................ 5,216 (1,515) 3,701 2,777 2,849 5,626 ------- -------- --------- -------- -------- ------- Total interest income...$ 5,570 $ (1,701) $ 3,869 $ 3,897 $ 3,119 $ 7,016 ------- -------- --------- -------- -------- ------- Interest Expense Interest on interest-bearing demand deposits......$ 558 $ (1,013) $ (455) $ 219 $ 1,587 $ 1,806 Interest on savings deposits...... 79 (124) (45) (87) 96 9 Interest on time deposits......... 1,921 195 2,116 1,538 2,157 3,695 Interest on borrowed funds........ 102 (48) 54 424 293 717 ------- -------- -------- -------- -------- -------- Total interest expense..$ 2,660 $ (990) $ 1,670 $ 2,094 $ 4,133 $ 6,227 ------- -------- -------- -------- -------- -------- Net interest income.....$ 2,910 $ (711) $ 2,199 $ 1,803 $ (1,014) $ 789 ======= ======== ======== ======== ======== ========
Provision for Loan Losses The provision for loan losses charged against earnings was $580,000 in 1996 compared to $534,000 in 1995 and $1,081,000 in 1994. The provision reflects the amount deemed appropriate by management to produce an adequate reserve to meet the present and foreseeable risk characteristics of the loan portfolio. Management's judgement is based on the evaluation of individual loans and their overall risk characteristics, past loan loss experience, and other relevant factors. Net charge-offs amounted to $560,000 in 1996, $394,000 in 1995 and $621,000 in 1994. The 1996 increase in net charge-offs compared to 1995 was due to substantial recoveries in 1995 that were not present in 1996. Gross charge- offs for 1996 were $703,000, a slight increase over the $676,000 reported in 1995. The allowance for loan losses as a percent of loans at December 31, 1995 was 1.82%, while at December 31, 1996 it was 1.65%. Non-Interest Income Table 3 - Non-Interest Income
1996/1995 1995/1994 Increase Increase (Decrease) (Decrease) 1996 Amount % 1995 Amount % 1994 Income from fiduciary activities.$ 1,139 $ 283 33.1% $ 856 $ 114 15.4% $ 742 Service charges on deposit accounts....................... 2,485 475 23.6% 2,010 212 11.8% 1,798 Other service charges, commissions and fees....................... 2,074 358 20.9% 1,716 177 11.5% 1,539 Mortgage banking income........... 1,192 667 127.0% 525 (110) (17.3%) 635 Other operating income............ 3,524 338 10.6% 3,186 857 36.8% 2,329 Investment securities gains or (losses)....................... 158 158 -- 0 0 .0% 0 ------ ------ ------ ------ ------- ------ ------ Total............................$10,572 $ 2,279 27.5% $8,293 $ 1,250 17.7% $7,043 ======= ======= ====== ====== ======= ====== ======
Non-interest income, recorded as other operating income, consists of income from fiduciary activities, service charges on deposit accounts, other service charges, commissions and fees, mortgage banking income and other income such as safe deposit box rents and income from operating leases. Income from fiduciary activities in the amount of $1,139,000 in 1996 was $283,000 or 33.1% greater than the $856,000 recorded in 1995. Income in 1995 was $114,000 or 15.4% greater than the $742,000 recorded in 1994. Fees increased primarily due to increased transaction volumes. Service charges on deposit accounts increased to $2,485,000, an increase of $475,000 or 23.6% over 1995 service charge income of $2,010,000. Service charges on deposit accounts in 1995 was $212,000 more than the $1,798,000 reported for 1994. Other service charges, commissions and fees amounted to $2,074,000 in 1996 compared to $1,716,000 in 1995 and $1,539,000 in 1994. Major contributors to the increase in 1996 were certain fees relating to VISA operations and fees received on mutual funds transactions. Income from mortgage banking activities increased to $1,192,000 in 1996 from $525,000 in 1995 due to two factors. Mortgages sold in the secondary market in 1996 increased to $33.2 million from $16.1 million in 1995. All mortgages sold were originated by the Bank's mortgage operation and branch network. No mortgages were acquired from third parties, nor have servicing rights been purchased from third parties. A low and reasonably stable interest rate environment in 1996, as well as an expansion in mortage products and services, resulted in the increase in volume in 1996. The Bank retains mortgage servicing rights on the majority of mortgages originated and sold on the secondary market. The Bank's mortgage servicing portfolio totaled $155 million as of December 31, 1996 compared to $142 million on December 31, 1995. The other component of mortgage banking profitability increase was a direct result of the implementation of FASB 122 (subsequently replaced by FASB 125) which required that mortgage servicing rights be recognized for their economic value, as of January 1, 1996. Mortgage servicing has a value because of future servicing income over the life of the mortgage. The value of servicing rights is available through third party purchasers in private transactions. The Bank has developed a business relationship with a third party mortgage company and values mortgage servicing from their price offerings. The Bank recognized $470,805 in mortgage servicing values in 1996 for its originated servicing portfolio, when in previous years no value was recognized. Mortgage servicing rights are recorded as an asset and recognized directly to income as if the servicing had been sold. The asset is amortized as a charge to earnings over the estimated servicing life of the associated mortgage. Mortgage servicing assets as of December 31, 1996 totaled $442,037. Actual pay-off of mortgages serviced with a recorded asset value are immediately charged against earnings. Other operating income increased $338,000 to $3,524,000 in 1996 from $3,186,000 in 1995. Other income for 1994 was $2,329,000. A major contributor to other operating income is income generated from operating leases. Income on operating leases increased over $430,000 in 1996 over 1995. This compares to an increase of over $476,000 in 1995 over 1994. Another contributor to the increase in 1995 was a gain on other real estate sold of nearly $270,000. Investment securities transactions reflect a gain of $158,000 in 1996 on securities sold, from the available-for-sale securities. There were no securities sold during 1995 or 1994. The Bank does not engage in trading activities. Therefore, there was no impact on current year earnings or a restatement of previously issued financial statements in connection with the adoption of SFAS 115. As a result of the above, total other operating income increased $2,279,000 in 1996 over 1995 compared to an increase of $1,250,000 in 1995 over 1994. Non-Interest Expense Table 4 - Non-Interest Expense
1996/1995 1995/1994 Increase Increase (Decrease) (Decrease) 1996 Amount % 1995 Amount % 1994 Salaries and employee benefits...$15,027 $ 1,987 15.2% $13,040 $ 776 6.3% $12,264 Net occupancy expense............. 2,109 388 22.5% 1,721 244 16.5% 1,477 Furniture & equipment expense..... 2,044 439 27.4% 1,605 226 16.4% 1,379 FDIC insurance assessment......... 2 (620)(99.7%) 622 (506) (44.9%) 1,128 Other operating expense........... 7,587 1,152 17.9% 6,435 630 10.9% 5,805 ----- ------ ----- ------ ----- ----- ------- Total............................$26,769 $ 3,346 14.3% $23,423 $1,370 6.2% $22,053 ======= ======= ===== ====== ====== ===== =======
Non-interest expense consists of salaries and employee benefits, net occupancy expense, furniture and equipment expense and other operating expenses. Total operating expenses for 1996 were $26,769,000 compared to $23,423,000 in 1995. This represented an increase of $3,346,000 or 14.3%. This compares to an increase of $1,370,000 or 6.2% in 1995. The largest component of the Corporation's other operating expense is salaries and employee benefits which increased to $15,027,000 in 1996 or $1,987,000 (15.2%) over the $13,040,000 reported in 1995. In 1995, expenses increased $776,000 (6.3%) over the $12,264,000 reported in 1994. The increase in 1996 and 1995 was primarily due to increases in staff as well as increases in wages and increased costs of employee benefits. During 1996 four branch offices were opened and two branch offices were acquired from another financial institution in December 1995. Occupancy expense increased $388,000 or 22.5% to $2,109,000 in 1996 from $1,721,000 in 1995. By comparison, during 1995, there was an increase of $244,000 or 16.5%. The Bank added four branch facilities to its network in 1996. In addition, the Bank completed construction of a new headquarters building in 1995 which also includes branch banking facilities and two branch offices were acquired from another financial institution in December 1995. These additions along with expenses relating to occupancy such as real estate taxes, insurance, utilities, maintenance and janitor services contributed to the increase in occupancy expense. Furniture and equipment expenses were $2,044,000 for 1996 and $1,605,000 for 1995. This represents an increase of $439,000 or 27.4%. Reflected in this increase is an increase of depreciation expense in 1996 amounting to $339,000. Service contracts on equipment was another major contributor to the increase in 1996. Expenses in 1995 were $226,000 greater than those recorded in 1994. There was a significant reduction in the FDIC insurance assessment in 1996 over 1995 as well as 1995 over 1994. Those reductions were a result of a new assessment rate schedule approved by the FDIC. Other operating expenses increased $1,152,000 or 17.9% in 1996 compared to an increase of $630,000 in 1995. The increase noted in 1996 is in line with rising costs associated with acquiring services covered in this category of expense. Expenses covered in this category include postage, Pennsylvania Shares Tax, advertising and marketing, professional services, telephone, stationery and forms, ATM fees, VISA fees, insurance premiums, expense of other real estate owned and other expense categories not specifically identified on the income statement. Contributing to the increase in 1996 were increases in marketing expense, Pennsylvania Shares Tax, professional services, postage, stationery and forms, VISA fees, MAC fees, telephone expense and training and development expense. Income Taxes Income tax expense totaled $3,147,000 in 1996 compared to $3,039,000 in 1995 and $2,637,000 in 1994. These increases resulted from higher levels of taxable income and increased earnings each year. The Corporation's effective tax rate was 24.3% in 1996 compared with 25.3% in 1995 and 24.2% in 1994. Utilization of tax credits in 1996 resulted in a lower effective tax rate than 1995 even though income before taxes increased. Additional information related to income taxation is presented in the Notes to Consolidated Financial Statements. Financial Condition Investment Portfolio Table 5 - Investment Securities at Cost The following table shows the amortized cost of the held-to-maturity securities owned by the Corporation as of the dates indicated. Investment securities are stated at cost adjusted for amortization of premiums and accretion of discounts. December 31, 1996 1995 1994 U.S. Treasury securities................$ 12,888 $ 18,837 $ 28,225 Obligations of other U.S. Government agencies and corporations............. 11,607 18,473 24,101 Obligations of states and political subdivisions.......................... 37,584 40,212 50,472 Mortgage-backed securities.............. 2,076 3,854 5,122 Other bonds, notes and debentures....... 27,269 38,944 50,811 --------- --------- --------- Subtotal................................ 91,424 120,320 158,731 Non-marketable securities............... 2,798 2,565 2,429 --------- --------- --------- Total...................................$ 94,222 $ 122,885 $ 161,160 ========= ========= ========= The following table shows the amortized cost and fair value of the available-for-sale securities owned as of the dates indicated. During December 1995, the Corporation was given the opportunity for a one-time transfer of securities from the held-to-maturity category to the available-for-sale category. As the table indicates, securities were moved to the available-for- sale category for U.S. Treasury securities, obligations of other U.S. Government agencies and corporations, obligations of states and political subdivisions and other bonds, notes and debentures. A total of $54,218,000 was moved from held-to-maturity to available-for-sale.
December 31, 1996 1995 1994 Amortized Fair Amortized Fair Amortized Fair Cost Value Cost Value Cost Value --------- --------- -------- -------- ----------- -------- U.S. Treasury securities............$ 13,611 $ 13,598 $ 11,046 $ 11,155 $ 1,472 $ 1,457 Obligations of other U.S. Government agencies and corporations.......... 18,800 18,718 15,489 15,632 none none Obligations of states and political subdivisions....................... 20,488 20,819 19,622 19,945 none none Mortgage-backed securities........... 1,125 1,117 1,249 1,242 1,344 1,256 Other bonds, notes and debentures.... 22,752 22,771 19,013 19,247 5,593 5,501 -------- --------- -------- -------- --------- -------- Subtotal............................. 76,776 77,023 66,419 67,221 8,409 8,214 Equity securities.................... 171 2,352 88 1,746 7 837 -------- --------- -------- -------- --------- -------- Total................................$ 76,947 $ 79,375 $ 66,507 $ 68,967 $ 8,416 $ 9,051 ======== ========= ======== ======== ========== ========
Table 6 - Investment Securities (Yields) The following table shows the maturities of held-to-maturity debt securities at amortized cost as of December 31, 1996 and approximate weighted average yields of such securities. Yields are shown on a tax equivalent basis, assuming a 34% Federal income tax rate.
Over 1 thru Over 5 thru 1 Year and less 5 Years 10 Years Over 10 Years Total Amount Yield Amount Yield Amount Yield Amount Yield Amount Yield U.S. Treasury securities....$ 7,322 5.56% $ 5,566 5.84% $ --- ---% $ --- ---% $ 12,888 5.68% Obligations of other U.S. Government agencies and corporations.. 1,903 5.72% 8,709 5.90% 994 7.02% --- ---% 11,606 5.97% Obligations of states and political sub- divisions..... 3,380 8.51% 12,486 6.52% 16,512 7.79% 5,206 7.48% 37,584 7.39% Mortgage-backed securities.... 114 8.34% 1,006 7.48% 577 8.45% 195 7.81% 1,892 7.86% Other bonds, notes and debentures.... 11,259 6.22% 16,195 6.35% --- ---% --- ---% 27,454 6.30% ------- ----- -------- ------ -------- ------ ------- ------ -------- ----- $23,978 6.31% $43,962 6.27% $ 18,083 7.77% $ 5,401 7.49% $91,424 6.65% ======= ===== ======= ====== ======== ===== ======= ====== ======== =====
The following table shows the maturities of available-for-sale debt securities at amortized cost as of December 31, 1996 and approximate weighted average yields of such securities. Yields are shown on a tax equivalent basis, assuming a 34% Federal income tax rate.
Over 1 thru Over 5 thru 1 Year and less 5 Years 10 Years Over 10 Years Total Amount Yield Amount Yield Amount Yield Amount Yield Amount Yield U.S. Treasury securities....$ 500 6.52% $ 12,793 5.95%$ 318 6.21% $ --- ---% $ 13,611 5.98% Obligations of other U.S. Government agencies and corporations.. 509 5.40% 12,485 6.23% 4,809 6.79% 997 8.15% 18,800 6.45% Obligations of states and political sub- divisions..... 258 6.89% 2,712 7.35% 14,087 7.93% 3,431 7.86% 20,488 7.83% Mortgage-backed securities.... 624 6.12% 501 5.99% --- ---% --- ---% 1,125 6.06% Other bonds, notes and debentures.... 1,300 5.95% 21,452 6.43% --- ---% --- ---% 22,752 6.40% ------- ------ ------- ------ ------- ----- ------- ----- -------- ------ $ 3,191 6.06% $49,943 6.30% $ 19,214 7.62% $ 4,428 7.93% $ 76,776 6.71% ======= ====== ======== ====== ======== ====== ======= ====== ======== ======
Loans Table 7 - Loan Portfolio The following table sets forth the composition of the Corporation's loan portfolio as of the dates indicated:
December 31, 1996 1995 1994 1993 1992 Commercial, financial and agricultural..............$ 239,701 $ 228,058 $ 208,918 $ 191,431 $ 172,482 Real estate-construction... 5,608 6,378 8,542 10,265 16,044 Real estate-mortgage....... 45,373 33,124 30,505 22,335 30,445 Consumer................... 136,989 116,210 106,921 101,256 99,444 Lease financing (net of unearned income)......... 47,346 43,904 38,771 35,443 32,768 ---------- ---------- ---------- ---------- --------- Total loans.................$ 475,017 $ 427,674 $ 393,657 $ 360,730 $ 351,183 ========== ========== ========== ========== =========
Table 8 - Loan Maturity and Interest Sensitivity The following table sets forth the maturity and interest sensitivity of the loan portfolio as of December 31, 1996: After one Within but within After one year five years five years Total Commercial, financial and agricultural..........$ 103,588 $ 116,403 $ 19,710 $ 239,701 Real estate-construction..... 1,807 1,280 2,521 5,608 --------- --------- --------- --------- $ 105,395 $ 117,683 $ 22,231 $ 245,309 ========= ========= ========= =========
Loans due after one year totaling $86,853,000 have variable interest rates. The remaining $53,061,000 in loans have fixed rates. Table 9 - Nonaccrual, Past Due and Restructured Loans The following table presents information concerning the aggregate amount of nonaccrual, past due and restructured loans:
December 31, 1996 1995 1994 1993 1992 Nonaccrual loans...........$ 1,193 $ 1,010 $ 2,127 $ 2,960 $ 4,129 Accruing loans, past due 90 days or more......... 737 330 1,127 522 519 ------- -------- -------- -------- -------- Total non-performing loans. 1,930 1,340 3,254 3,482 4,648 Other real estate owned.... 81 252 759 251 360 ------- -------- -------- -------- -------- Total non-performing assets$ 2,011 $ 1,592 $ 4,013 $ 3,733 $ 5,008 ======= ======== ======== ======== ======== Ratios: Non-performing loans to total loans.......... .41% .31% .83% .97% 1.33% Non-performing assets to total loans and other real estate owned.... .42% .37% 1.02% 1.04% 1.44% Non-performing assets to total assets.......... .26% .22% .63% .63% .92% Allowance for loan losses to non-performing loans.. 404.1% 580.6% 234.8% 206.2% 116.1%
The economic conditions within the Corporation's market area remained healthy in 1996. This is reflected in the unemployment rate for Lancaster County, which is the Bank's primary market area. The jobless rate remained low during the past year with fluctuations between 3.8% and 2.8%. Lancaster County's unemployment rate has historically been and continues to be one of the lowest among Pennsylvania's 14 metropolitan regions. It also remains well below the state unemployment rate of 4.79% that was reported for November 1996. The 2.8% reported in November is the lowest rate since 1989. Predictions for the local economy range from "solid improvement" to a "flat economy with declining interest rates and low inflation". The strength in the employment sector in Lancaster County was also seen at the national level. Jobs grew by a strong 2.6 million in 1996 and the employment rate held steady at 5.3% for December. The unemployment rate for December 1995 stood at 5.6%. The strong job growth, particularly evidenced in December 1996, provided further evidence that the economy ended 1996 at a faster clip than analysts had expected. Economists are predicting the U.S. economy will grow about the same rate as 1996. The Bank's loan delinquency, as a percent of loans outstanding increased during 1996. At December 31, 1996, this rate stood at .96% compared to .58% and 1.33% for December 31, 1995 and December 31, 1994, respectively. The increase in the delinquency rates was primarily experienced in the retail portfolio, particularly in the installment and credit card portfolios. The Bank is not immune to the rising number of bankruptcies that occurred in 1996 nationwide. While management believes delinquency rates could continue to trend upward during 1997, expectations are that they will not approach the national delinquency rates. The .96% remains well below the accepted level established by management. During the year, total nonaccrual loans and other real estate owned increased slightly to $1,274,000 from $1,262,000 at December 31, 1995. Total non- performing assets increased to $2,011,000 compared to $1,592,000 for December 31, 1995 representing a 26% increase. The increase was primarily attributed to increases in the 90 day delinquency categories. Other real estate declined while nonaccruals increased slightly. Management is taking steps to ensure non-performing assets do not reach unacceptable levels. The Bank's reserve coverage declined during the year as reserves, as a percent of non-performing loans, declined to 404% compared with 581% for December 31, 1995 and 235% for 1994. A portion of the Bank's loan portfolio consists of loans to agricultural- related borrowers. These loans consist of loans for a variety of purposes within the industry. Lancaster County continues to be the top agricultural county in the state, leading Pennsylvania in production of most crops and all livestock with the exception of sheep. Dairy production remains Lancaster County's number one agricultural industry. Indications are that some segments of Lancaster County farming are showing promising growth while others are moving ahead at a steady pace. While the Bank is hopeful that this portion of its loan portfolio will continue to show growth, it should be noted that these loans are susceptible to a variety of external factors such as adverse climate, economic conditions, etc., in addition to factors common to other industries. The residential real estate market in 1996 for Lancaster County produced a strong performance. Home sales rose more than 6% from the previous year. Reasonably low interest rates and a strong economy accounted for the performance. Strong home sales are predicted through at least the first half of 1997. Compared to 1995, 1996 was a soft year for non-residential construction. In 1995, Lancaster County experienced a non-residential construction boom when contracts jumped 79%. Builders expect 1997 to be a very good year for non-residental construction. Most of the Bank's business activity is with customers located within the Bank's defined market area. Since the majority of the Bank's real estate loans are located within this area, a substantial portion of the debtor's ability to honor their obligations and increases and decreases in the market value of the real estate collateralizing such loans may be affected by the level of economic activity in the market area. The general policy has been to cease accruing interest on loans when it is determined that a reasonable doubt exists as to the collectibility of additional interest. Interest income on these loans is only recognized to the extent payments are received. Loans on a nonaccrual status amounted to $1,193,000 at December 31, 1996 compared to $1,010,000 at December 31, 1995. If interest income had been recorded on all such loans for the years indicated, such interest income would have been increased by approximately $116,567 and $143,997 for 1996 and 1995 respectively. Interest income recorded on non-accrual loans amounted to $27,532 and $93,795 for 1996 and 1995 respectively. Potential problem loans are loans which are included as performing loans but for which possible credit problems of the borrower causes management to have doubts as to the ability of such borrower to comply with present repayment terms and which may eventually result in disclosure as a non-performing loan. At December 31, 1996 there were no such loans that had to be disclosed as potential problem loans. SFAS No. 118, "Accounting by Creditors for Impairment of a Loan - Income Recognition and Disclosures", an amendment of SFAS No. 114, was implemented at the beginning of 1995. The Bank has defined impaired loans as all loans on nonaccrual status, except those specifically excluded from the scope of SFAS No. 114, regardless of the credit grade assigned by loan review. All impaired loans were measured by utilizing the fair value of the collateral for each loan. When the measure of an impaired loan is less than the recorded investment in the loan, the Bank will compare the impairment to the existing allowance assigned to the loan. If the impairment is greater than the allowance, the Bank will adjust the existing allowance to reflect the greater amount or take a corresponding charge to the provision for loan losses. If the impairment is less than the existing allowance for a particular loan, no adjustments to the allowance or the provision for loan and lease losses will be made. There was no adjustment necessary for the impaired loans for the periods indicated. The following table presents information concerning impaired loans at December 31: 1996 1995 Gross impaired loans which have allowances..........$1,193 $1,010 Less: Related allowances for loan losses......... (179) (349) ------ ------ Net impaired loans..................................$1,014 $ 661 ====== ====== At December 31, 1996, there were no concentrations exceeding 10% of total loans. A concentration is defined as amounts loaned to a multiple number of borrowers engaged in similar activities which would cause them to be similarly affected by changes in economic or other conditions. There were no foreign loans outstanding at December 31, 1996. Allowance for Loan Losses Table 10 - Summary of Loan Loss Experience Years ended December 31, 1996 1995 1994 1993 1992 Allowance for Loan Losses: Beginning balance.............$ 7,780 $ 7,640 $ 7,180 $ 5,400 $ 4,400 Loans charged off during year: Commercial, financial and agricultural.............. 37 50 157 194 843 Real estate mortgage........ 184 252 235 392 201 Consumer.................... 458 360 360 290 471 Lease financing............. 24 14 10 14 97 ------- ------- ------- ------- ------- Total charge-offs........... 703 676 762 890 1,612 ------- ------- ------- ------- ------- Recoveries: Commercial, financial and agricultural.............. 5 117 61 157 232 Real estate mortgage........ 42 72 2 8 none Consumer.................... 88 91 77 63 76 Lease financing............. 8 2 1 12 8 ------- ------- ------- ------- ------- Total recoveries............ 143 282 141 240 316 ------- ------- ------- ------- ------- Net loans charged off......... 560 394 621 650 1,296 Additions charged to operations.................. 580 534 1,081 2,430 2,296 ------- ------- ------- ------- ------- Balance at end of year........$ 7,800 $ 7,780 $ 7,640 $ 7,180 $ 5,400 ======= ======= ======= ======= ======= Ratio of net loans charged off to average loans outstanding................. .12% .10% .17% .18% .39% Ratio of net loans charged off to loans at end of year. .12% .09% .16% .18% .37% Net loans charged off to allowance for loan losses.. 7.18% 5.06% 8.13% 9.05% 24.00% Net loans charged off to provision for loan losses.. 96.55% 73.78% 57.45% 26.75% 56.45% Allowance for loan losses as a percent of average loans... 1.69% 1.91% 2.04% 2.01% 1.64% Allowance for loan losses as a percent of loans at end of year................ 1.65% 1.82% 1.95% 2.00% 1.55% Allowance for loan losses as a percent of non-performing loans....... 404.1% 580.6% 234.8% 206.2% 116.1% The Bank experienced a 4% increase in gross charge-offs, while net charge- offs increased 42%. 1995 was an exceptionally good year for recoveries, thus the substantial difference between the increase in gross charge-offs and net charge-offs. For the year, the Bank recorded net charge-offs of $560,000 or .12% of average loans outstanding, compared to $394,000 or .10% of average loans in 1995 and $621,000 or .17% of average loans in 1994. The provision for loan losses charged to operating expense reflects the amount deemed appropriate by management to produce an adequate reserve to meet the present and inherent risk deemed present in the loan portfolio. Management performs a quarterly assessment of the loan portfolio to determine the appropriate level of allowance. The factors considered in this evaluation include, but are not limited to, estimated loan losses identified through a loan review process, general economic conditions, deterioration in pledged collateral, past loan experience and trends in delinquencies and non-accruals. Management uses available information to determine the appropriate level of the allowance for possible loan losses. However, the allowance may be affected in the future based upon changes in the economic conditions and other factors. While there can be no assurance that material amounts of additional loan loss provisions will not be required in the future, management believes that, based upon information presently available, the amount of the allowance for possible loan losses is adequate. Management has not targeted any specific coverage ratio of non-performing loans by the allowance for loan losses and the coverage ratio may fluctuate based on loans placed into or removed from non-performing status. Table 11 - Allocation of Allowance for Loan Losses December 31, 1996 1995 Commercial, financial and agricultural..........$ 3,471 $ 3,710 Real estate - mortgage.......................... 5 3 Consumer........................................ 590 523 Leases.......................................... 620 600 Unallocated..................................... 3,114 2,944 ------- ------- Total...........................................$ 7,800 $ 7,780 ======= ======= Deposits Table 12 - Average Deposit Balances and Rates Paid The average amounts of deposits and rates paid for the years indicated are summarized below:
1996 1995 1994 Amount Rate Amount Rate Amount Rate Demand deposits.....................$ 72,052 --- $ 66,133 --- $ 64,446 --- Interest-bearing demand deposits.... 257,622 2.61% 239,036 3.00% 229,693 2.34% Savings deposits.................... 58,232 2.21% 54,982 2.42% 58,864 2.25% Time deposits....................... 229,835 5.52% 194,512 5.44% 158,994 4.33% -------- ----- -------- ----- -------- ----- $617,741 3.35% $554,663 3.44% $511,997 2.65% ======== ===== ======== ===== ======== =====
Table 13 - Deposit Maturity The maturities of time deposits of $100,000 or more are summarized below: December 31, 1996 1995 Three months or less..........................$ 6,095 $ 5,881 Over three thru six months.................... 6,112 3,811 Over six thru twelve months................... 9,026 5,270 Over twelve months............................ 5,963 8,976 ------- ------- Total.........................................$ 27,196 $ 23,938 ======= ======= Capital Stockholders' equity increased nearly $5.3 million or 8.2% in 1996 to $69,179,000. Total stockholders' equity at December 31, 1995 in the amount of $63,909,000 represents an increase of $6.6 million or 11.6% over the $57,285,000 reported at December 31, 1994. Net earnings retained after the payment of dividends as well as capital acquired through stock issued pursuant to a dividend reinvestment and stock purchase plan and employee stock plan generated the greatest portion of this growth in stockholders' equity. There was no significant change in equity as a result of change in net unrealized gain on securities available-for-sale, net of taxes. Stockholders' equity increased $1.2 million in 1995 due to an increase in net unrealized gains on investment securities available-for-sale, net of taxes. Included in dividends declared for 1995 is $1,478,000 which represents a $.25 per share "Special Dividend" which was declared in the second quarter of 1995. Dividends declared amounted to $4,508,000, $5,260,000 and $3,386,000 for 1996, 1995 and 1994 respectively. Federal regulatory authorities approved risk-based capital guidelines applicable to banks and bank holding companies in an effort to make regulatory capital more responsive to the risk exposure related to various categories of assets and off- balance sheet items. These guidelines require that banking organizations meet a minimum risk-based capital, define the components of capital, categorize assets into different risk classes and include certain off-balance sheet items in the calculation of capital requirements. The components of total capital are called Tier 1 and Tier 2 capital. In the case of the Bank, Tier 1 capital is the shareholders' equity and Tier 2 capital is the allowance for loan losses. The risk-based capital ratios are computed by dividing the components of capital by risk-weighted assets. Risk-weighted assets are determined by assigning various levels of risk to different categories of assets and off-balance sheet items. Regulatory authorities have decided to exclude the net unrealized holding gains and losses on available-for-sale securities from the definition of common stockholders' equity for regulatory capital purposes. However, national banks will continue to deduct unrealized losses on equity securities in their computation of Tier 1 capital. Therefore, national banks will continue to report the net unrealized holding gains and losses on available-for-sale securities in the reports of condition and income submitted to federal regulators as required by SFAS 115 and the financial reports prepared in accordance with generally accepted accounting principles, but will exclude these amounts from calculations of Tier 1 capital. In addition, national banks should use the amortized cost of available-for-sale debt securities (as opposed to fair value) to determine the average total assets as well as the risk-weighted assets used in the calculations of the leverage and risk-based capital ratios. The ratios below and in Table 14 reflect the above definition of common stockholders' equity which includes common stock, capital surplus and retained earnings, less net unrealized holding losses on available-for-sale equity securities with readily determinable fair values. The Bank's ratios at December 31, 1996, 1995 and 1994 were above the final risk-based capital standards that require Tier 1 capital of at least 4% and total risk-based capital of 8% of risk-weighted assets. The Tier 1 capital ratio at December 31, 1996 was 10.68% and the total risk-based capital ratio was 11.93%, which exceeds the minimum capital guidelines. Tier 1 capital ratio was 10.95% and the total risk-based capital ratio was 12.21% at December 31, 1995 while Tier 1 capital ratio was 11.05% and the total risk-based capital ratio was 12.3% at December 31, 1994. On December 4, 1996, the Bank purchased a property located at 1097 Commercial Avenue, East Petersburg, PA situated on 12.7 acres with a building containing approximately 123,000 square feet. The building is used to house the Bank's Administrative Service Center, as well as other departments of the Bank. Town & Country, Inc., a wholly owned subsidiary of the Bank, also occupies this building. The purchase price of the property was approximately $5.3 million. The capital expenditures relating to this building were financed out of existing capital resources. The Bank did not and does not expect to incur any indebtedness relating to this new facility. The reduction in earning assets and the expenses relating to the new facilities will be offset somewhat to the extent the building which previously housed the Administrative Service Center was sold for approximately $1.2 million and settlement took place on February 21, 1997. In addition, the building formerly occupied by Town & Country, Inc. is also under agreement of sale and settlement should take place on or before April 1, 1997. Efforts are being made to secure tenants for the additional available space in the recently purchased Administrative Service Center building. Management does not expect this to have a material impact on future reported results of operations, even though this will result in the application of a material amount of capital. The opportunity to acquire the Commercial Avenue facility came at a time when management had been considering options to expand its current Administrative Service Center. While exceeding the Bank's current space needs, the Commercial Avenue facility purchase was financially superior to expanding the existing facility. At the same time, it also provides significant future growth capacity. Table 14 - Capital and Performance Ratios The following are selected ratios for the years ended December 31:
1996 1995 1994 Return on average assets...................... 1.34% 1.36% 1.38% Return on average equity...................... 15.01% 15.02% 15.47% Dividend payout ratio......................... 45.95% 58.48% 40.91% Average total equity to average assets........ 8.95% 9.10% 8.89% Total equity to assets at year end............ 8.87% 8.79% 8.99% Primary capital ratio......................... 9.80% 9.78% 10.07% Tier 1 risk-based capital ratio............... 10.68% 10.95% 11.05% Total risk-based capital ratio................ 11.93% 12.21% 12.30%
Liquidity and Interest Rate Sensitivity Liquidity is the ability to meet the requirements of customers for loans and deposit withdrawals in the most economical manner. Some liquidity is ensured by maintaining assets which may be immediately converted into cash at minimal cost. Liquidity from asset categories is provided through cash, noninterest-bearing and interest-bearing deposits with banks, federal funds sold and marketable investment securities maturing within one year. Securities maturing within one year amounted to $27,169,000 at December 31, 1996 compared to $30,833,000 at December 31, 1995. Interest-bearing deposits with banks totaled $643,498 at December 31, 1996 compared to $24,158 at December 31, 1995. Federal funds sold totaled $24,150,000 at December 31, 1996 compared to $9,350,000 sold at December 31, 1995. Securities available-for-sale as of December 31, 1996 were $79,374,627 compared to $68,967,132 as of December 31, 1995. The loan portfolio also provides an additional source of liquidity due to Bank of Lancaster County participating in the secondary mortgage market. Sales of residential mortgages into the secondary market were approximately $33.2 million in 1996 and $16.1 million in 1995, which allowed the Bank to meet the needs of customers for new mortgage financing. The loan portfolio also provides significant liquidity by repayment of loans by maturity or scheduled amortization payments. On the liability side, liquidity is available through customer deposit growth and short term borrowings. Federal Home Loan Bank available borrowing capacity as of December 31, 1996 was $15,910,000 with existing capital stock ownership and $21,500,000 in federal funds purchased lines are in place. Liquidity must constantly be monitored because future customer demands for funds are uncertain. The amount of liquidity needed is determined by the changes in levels of deposits and in the demand for loans. Management believes that the sources of funds mentioned above provide sufficient liquidity. Interest sensitivity is related to liquidity because each is affected by maturing assets and sources of funds. Interest sensitivity, however, is also concerned with pricing changes of assets and liabilities not maturing, and values of assets and liabilities as a result of rate changes. Also, future income may be impacted as a result of rate change valuations on non-balance sheet commitments. Management endeavors to manage the exposure of earnings to changes in interest rates. The Bank's asset/liability committee manages interest rate risk by various means including "GAP" management and internally developed reporting. Management has committed to supplement this process in 1997 with Sheshunoff Interest Rate Risk management services. The Bank has various investments structured to change investment yield with current market conditions. Assets subject to repricing include federal funds sold (repricing daily), loans tied to "Treasury Bill" indexes (repricing monthly) and loans tied to "prime" or other indexes subject to immediate change. In addition to repricable assets are maturing and contracted repayments and prepayments of existing loans and investments. These cash flows will be re-invested at current market yields. The Bank's funding liabilities (customer deposits and borrowed funds) have more complex repricing characteristics, since interest bearing deposits are subject to rate change but are not specifically indexed to "prime" or "treasury" indexes. Time certificates and borrowed money are subject to interest rate change at maturity. Interest rate sensitivity relates to earnings and economic impact to the Bank with changing interest rates. Earning assets and funding can be subject to interest rate repricing with changing market conditions. In addition, investments, loans, time deposits and debt maturities and prepayments will be subject to current market rates with reinvestment. The net result of interest rate repricings will impact the Bank's future net interest margins (either in a positive or negative manner) based on the amount of unmatched funding, the amount of rate change, and the direction of rate change. The net volume of earning assets and deposit funding subject to rate change is measured in time period "gaps" where volumes of earning assets and deposit funding are measured to determine the amount of the unmatched position. These gaps are illustrated in Table 15. The regulatory presentation depicts all interest bearing deposits as being subject to immediate and full repricing. Management considers factors in addition to volume of liability funding (deposits) subject to rate change to more accurately reflect future impact to the net interest margin. All interest rates do not move in full and equal amounts for loans and deposits. Deposit rates historically lag loans in rate movement, and rate movement occurs to a smaller degree for deposits than loans. Modeling is used to forecast projected impact to the net interest margin as a result of rate movements, either increasing or decreasing. For example, prime base rate has changed 21 times since 1988 (movement from a high of 11.5% to a low of 6.0% - a range of 5.5%). During this period, NOW account deposit rates have also experienced rate changes (movement from a high of 4.85% to a low of 1.40% - a range of 3.45%). Historic pricing correlations have been calculated for all interest-bearing products for rate change repricing impact as - immediate, monthly and annually over one year time periods. As illustrated in Table 15, management's view of interest rate sensitivity reflects a calculated interpretation of net interest margin exposure to rate changes. Pricing correlations are constantly refined by management. There is no guarantee that past history will accurately reflect future changes. Interest repricing of assets and liabilities is measured over future time periods (interest rate sensitivity gaps). While all time gaps are measured, management's primary focus is the cumulative gap through six months, as this time frame directly impacts net interest income in the near term time horizon and is most difficult to make reactive adjustment to actual rate movements. During 1996, the net interest income tax-equivalent yield on average earning assets dropped to 4.86% from 4.99% in 1995. The prime rate in 1996 started at 8.50%, moving down in February to 8.25% and staying at that level for the remainder of the year. The average tax-equivalent yield on earning assets decreased in 1996 to 8.38%, down from 8.59% in 1995. Average earning assets increased by $60,750,000 to $647,846,871 in 1996. Deposit funding (average balances) increased $63,000,000 in 1996. Total deposit cost decreased to 3.35% from 3.44% in 1995. The net interest margin (tax equivalent) decreased to 4.86% in 1996 from 4.99% in 1995. Compression of the net interest margin was primarily a result of a competitive lending environment, with tax equivalent yields on loans decreasing to 9.05% in 1996 from 9.38% in 1995, while lending volume increased $55,600,000. Table 15 - Interest Rate Sensitivity Gaps
0-30 31-90 91-180 181-365 Over 1 Over 2 Over 3 Over 4 Over Interest Earning Days Days Days Days to 2 Yrs to 3 Yrs to 4 Yrs to 5 Yrs 5 Yrs Assets (I.E.A.) Fed Funds sold......$ 24,150 $ 0 $ 0 $ 0 $ 0 $ 0 $ 0 $ 0 $ 0 Investment securities- Maturities.......... 2,833 5,070 6,453 13,959 32,185 25,007 21,686 9,420 57,627 Loans - Maturities... 5,087 8,662 12,399 21,225 41,882 35,655 25,090 16,439 54,522 Loans - Variable Rate 98,652 1,402 3,512 8,501 13,085 10,727 3,451 13,407 53,967 Leases - Finance..... 1,016 2,083 3,170 6,461 13,699 9,589 6,712 4,616 0 -------- -------- -------- -------- -------- -------- -------- -------- ------- Total...............$ 131,738 $ 17,217 $ 25,534 $ 50,146 $ 100,851 $ 80,978 $ 56,939 $ 43,882 $166,116 Cumulative..........$ 131,738 148,955 174,489 224,635 325,486 406,464 463,403 507,285 673,401 Interest Bearing Liabilities(I.B.L.) C/D's $100,000 and over...............$ 402 $ 3,454 $ 7,301 $ 4,463 $ 0 $ 965 $ 133 $ 0 $ 200 C/D - Maturities.... 12,354 23,971 46,636 46,061 43,774 32,685 10,117 4,750 1,557 Interest Deposits - Variable Rate..... 75,915 22,725 4,414 9,448 14,772 14,772 16,772 14,771 152,449 Short-term borrowings........ 2,741 0 0 0 0 0 0 0 0 Borrowings - Leasing Operations......... 1,100 1,920 2,610 4,360 8,080 6,040 3,740 1,584 1,001 -------- -------- -------- -------- -------- -------- -------- -------- ------- Total...............$ 92,512 $ 52,070 $ 60,961 $ 64,332 $ 66,626 $ 54,462 $ 30,762 $ 21,105 $155,207 Cumulative..........$ 92,512 $ 144,582 $ 205,543 $ 269,875 $ 336,501 390,963 421,725 442,830 598,037 Period GAP (Dollars)$ 39,226 $ (34,853)$ (35,427)$ (14,186)$ 34,225 $ 26,516 $ 26,177 $ 22,777 $ 10,909 I.E.A./I.B.L.%...... 142% 33% 42% 78% 151% 149% 185% 208% 107% Cumulative GAP (Dollars)..........$ 39,226 $ 4,373 $ (31,054)$ (45,240)$ (11,015)$ 15,501 $ 41,678 $ 64,455 $ 75,364 Cumulative I.E.A./I.B.L.%...... 142% 103% 85% 83% 97% 104% 110% 115% 113% Regulatory Presentation Assets (cumulative).$ 131,738 $ 148,955 $ 174,489 $ 224,635 $ 325,486 $ 406,464 $ 463,403 $ 507,285 $673,401 Funding (cumulative)$ 342,635 $ 371,980 $ 428,527 $ 483,411 $ 535,265 574,955 588,945 595,279 598,037 -------- -------- -------- -------- -------- -------- -------- -------- ------- Cumulative GAP (Dollars)..........$(210,897)$(223,025)$(254,038)$(258,776)$(209,779)$(168,491)$(125,542)$ (87,994)$ 75,364 Cumulative I.E.A./I.B.L.%..... 38% 40% 41% 46% 61% 71% 79% 85% 113%
New Financial Accounting Standard In June 1996, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards ("SFAS") No. 125 - "Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities". This Statement amends and extends to all servicing assets and libilities the accounting standards for mortgage servicing rights now in FASB Statement No. 65, "Accounting for Certain Mortgage Banking Activities", and supercedes FASB Statement No. 122, "Accounting for Mortgage Servicing Rights". SFAS No. 125 establishes accounting and reporting standards for transfers and servicing of financial assets and extinguishments of liabilities based on the consistent application of the financial-components approach. This approach requires the recognition of financial assets and servicing assets that are controlled by the reporting entity, the derecognition of financial assets when control is surrendered and the derecognition of liabilities when they are extinguished. Specific criteria are established for determining when control has been surrendered in the transfer of financial assets. Liabilities and deriviatives incurred or obtained by transferors in conjunction with the transfer of financial assets are required to be measured at fair value, if practicable. Servicing assets and other retained interests in transferred assets are required to be measured by allocating the previous carrying amount between the assets sold, if any, and the interest that is retained, if any, based on the relative fair values of the assets at the date of the transfer. Servicing assets retained are subsequently subject to amortization and assessment for impairment. As issued, this Statement is effective for transfers and servicing of financial assets and extinguishments of liabilities occurring after December 31, 1996, and is to be applied prospectively. The FASB was made aware that the volume and variety of certain transactions and the related changes to information systems and accounting processes that are necessary to comply with the requirement of SFAS No. 125 would make it extremely difficult, if not impossible, for some affected enterprises to apply the transfer and collateral provisions of the Statement to those transactions as soon as January 1, 1997. As a result, in December 1996, the FASB issued FASB No. 127, "Deferral of the Effective Date of Certain Provisions of FASB Statement No. 125" that defers for one year the effective date of these provisions, as well as accounting for transfers and servicing for repurchase agreement, dollar-roll, securities lending and similar transactions. Therefore, this Statement shall be effective for such transfers of financial assets after December 31, 1997. Sterling has determined that the adoption of SFAS No. 127 is not expected to have a material effect on the financial position or results of operations of the Corporation. Item 8 - Financial Statements and Supplementary Data (a) The following audited consolidated financial statements and related documents are set forth in this Annual Report on Form 10-K on the following pages: Page Report of Independent Auditors 33 Consolidated Balance Sheets 34 Consolidated Statements of Income 35 Consolidated Statements of Changes in Stockholders' Equity 36 Consolidated Statements of Cash Flows 37 Notes to Consolidated Financial Statements 39 (b) The following supplementary data is set forth in this Annual Report on Form 10-K on the following pages: Summary of Quarterly Financial Data (Unaudited) 63 Trout, Ebersole & Groff, LLP Certified Public Accountants 1705 Oregon Pike Lancaster, Pennsylvania 17601 (717)569-2900 FAX (717) 569-0141 Independent Auditors' Report Board of Directors and Shareholders Sterling Financial Corporation and Subsidiaries Lancaster, Pennsylvania We have audited the accompanying consolidated balance sheets of Sterling Financial Corporation and Subsidiaries as of December 31, 1996 and 1995, and the related consolidated statements of income, stockholders' equity, and cash flows for each of the three years in the period ended December 31, 1996. These financial statements are the responsibility of management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Sterling Financial Corporation and Subsidiaries at December 31, 1996 and 1995 and the consolidated results of their operations and their cash flows for each of the three years in the period ended December 31, 1996, in conformity with generally accepted accounting principles. As discussed in Note 2, the Corporation changed its method of accounting for mortgage servicing rights to adopt the provisions of the Financial Accounting Standards Board's SFAS No. 122, "Accounting for Mortgage Servicing Rights", at January 1, 1996. Trout, Ebersole & Groff, LLP Trout, Ebersole & Groff, LLP Certified Public Accountants January 24, 1997 Lancaster, Pennsylvania Consolidated Balance Sheets Sterling Financial Corporation and Subsidiaries
As of December 31, (Dollars in thousands) 1996 1995 Assets Cash and due from banks...........................................$ 31,339 $ 35,414 Interest-bearing deposits in other banks.......................... 644 24 Federal funds sold................................................ 24,150 9,350 Mortgage loans held for sale...................................... 1,016 962 Investment Securities: (Note 4) Securities held-to-maturity (market value - $94,778 - 1996 and $124,066 - 1995)............ 94,222 122,885 Securities available-for-sale.................................... 79,375 68,967 Loans (Note 5).................................................... 475,017 427,674 Less: Unearned income........................................... (1,185) (1,362) Allowance for loan losses (Note 6)......................... (7,800) (7,780) -------- ------- Loans, net........................................................ 466,032 418,532 -------- ------- Premises and equipment (Note 7)................................... 22,658 16,450 Other real estate owned........................................... 81 252 Accrued interest receivable and prepaid expenses.................. 11,262 11,779 Other assets (Note 8)............................................. 33,293 26,539 -------- ------- Total Assets..................................................... $764,072 $711,154 ======== ======== Liabilities Deposits: Noninterest-bearing.............................................$ 82,175 $ 77,318 Interest-bearing (Note 9)....................................... 564,861 532,787 -------- -------- Total Deposits.................................................... 647,036 610,105 -------- -------- Interest-bearing demand notes issued to U.S. Treasury (Note 10)... 2,741 2,234 Other liabilities for borrowed money (Note 10).................... 30,434 21,523 Accrued interest payable and accrued expenses..................... 8,705 8,231 Other liabilities................................................. 5,977 5,152 -------- -------- Total Liabilities................................................. 694,893 647,245 Stockholders' Equity -------- -------- Common Stock -(par value:$5.00) No. shares authorized: 1996 - 35,000,000; 1995 - 10,000,000 No. shares issued: 1996 - 6,237,009; 1995 - 5,932,686 No. shares outstanding: 1996 - 6,220,078; 1995 - 5,925,527...... 31,185 29,663 Capital surplus................................................... 16,325 9,987 Retained earnings................................................. 20,502 22,848 Net unrealized gain on securities available-for-sale, net of taxes 1,603 1,624 Less: Treasury Stock (16,931 shares in 1996 and 7,159 shares in 1995) - at cost........................... (436) (213) -------- -------- Total Stockholders' Equity........................................ 69,179 63,909 -------- -------- Total Liabilities and Stockholders' Equity........................$764,072 $711,154 ======== ======== See accompanying notes to financial statements
Consolidated Statements of Income Sterling Financial Corporation and Subsidiaries
For the years ended December 31, (Dollars in thousands, except per share data) 1996 1995 1994 Interest Income Interest and fees on loans...........................$ 41,611 $ 37,975 $ 32,356 Interest on deposits in other banks.................. 6 2 2 Interest on federal funds sold....................... 398 449 264 Interest and dividends on investment securities: Taxable............................................ 7,442 7,526 6,636 Tax-exempt......................................... 2,882 2,695 2,496 Dividends on stock................................. 219 203 177 --------- --------- --------- Total Interest Income................................ 52,558 48,850 41,931 --------- --------- --------- Interest Expense Interest on time certificates of deposit of $100,000 or more................................... 934 893 613 Interest on all other deposits....................... 19,775 18,200 12,970 Interest on demand notes issued to the U.S. Treasury. 95 114 77 Interest on federal funds purchased.................. 89 66 10 Interest on other borrowed money..................... 1,930 1,880 1,255 Interest on mortgage indebtedness and obligations under capitalized leases........................... none none 1 --------- --------- --------- Total Interest Expense............................... 22,823 21,153 14,926 --------- --------- --------- Net Interest Income.................................. 29,735 27,697 27,005 Provision for loan losses (Note 6)................... 580 534 1,081 --------- --------- --------- Net Interest Income after Provision for Loan Losses.. 29,155 27,163 25,924 --------- --------- --------- Other Operating Income Income from fiduciary activities..................... 1,139 856 742 Service charges on deposit accounts.................. 2,485 2,010 1,798 Other service charges, commissions and fees.......... 2,074 1,716 1,539 Mortgage banking..................................... 1,192 525 635 Other operating income (Note 8)...................... 3,524 3,186 2,329 Investment securities gains or (losses).............. 158 none none --------- --------- --------- Total Other Operating Income......................... 10,572 8,293 7,043 --------- --------- --------- Other Operating Expenses Salaries and employee benefits (Note 11)............. 15,027 13,040 12,264 Net occupancy expense................................ 2,109 1,721 1,477 Furniture and equipment expense (including depreciation of $1,256 in 1996, $917 in 1995 and $779 in 1994).. 2,044 1,605 1,379 FDIC insurance assessment............................ 2 622 1,128 Other operating expenses............................. 7,587 6,435 5,805 --------- --------- --------- Total Other Operating Expenses....................... 26,769 23,423 22,053 --------- --------- --------- Income Before Income Taxes........................... 12,958 12,033 10,914 Applicable income taxes (Note 12).................... 3,147 3,039 2,637 --------- --------- --------- Net Income...........................................$ 9,811 $ 8,994 $ 8,277 ========= ========= ========= Earnings per common share: Net Income.........................................$ 1.57 $ 1.45 $ 1.35 Cash dividends declared per common share.............$ .74 $ .89 $ .58 Average shares outstanding...........................6,235,257 6,204,212 6,128,058
See accompanying notes to financial statements Consolidated Statements of Changes in Stockholders' Equity Sterling Financial Corporation and Subsidiaries
Net Unrealized Gain on Available- Shares for-Sale Common Common Capital Retained Securities, Treasury Stock Stock Surplus Earnings Net of Taxes Stock Total (Dollars in thousands) Balance, January 1, 1994..... 2,882,920 $ 14,414 $ 20,830 $ 14,223 $ 0 $ 0$ 49,467 Net income.................... 8,277 8,277 Common stock issued Dividend Reinvestment Plan... 55,255 277 2,005 2,282 Employee Stock Plan.......... 8,830 44 319 363 Two-for-one stock split....... 2,927,412 14,637 (14,637) Cash dividends declared - Common stock................. (3,386) (3,386) Purchase of Treasury Stock (14,471 shares).............. (379) (379) Issuance of Treasury Stock for Dividend Reinvestment Plan (8,664 shares)............... 27 214 241 Net unrealized gain on available- for-sale securities, net of taxes 420 420 ---------- -------- -------- -------- ---------- ------- -------- Balance, December 31, 1994.... 5,874,417 29,372 8,544 19,114 420 (165) 57,285 Net income.................... 8,994 8,994 Common stock issued Dividend Reinvestment Plan... 45,121 225 1,115 1,340 Employee Stock Plan.......... 13,148 66 325 391 Cash dividends declared - Common stock................. (5,260) (5,260) Purchase of Treasury Stock (41,880 shares).............. (1,252) (1,252) Issuance of Treasury Stock for Dividend Reinvestment Plan (40,528 shares).............. 3 1,204 1,207 Change in net unrealized gain on available-for-sale securities, net of taxes................. 1,204 1,204 --------- -------- -------- -------- ---------- ------- -------- Balance, December 31, 1995....5,932,686 29,663 9,987 22,848 1,624 (213) 63,909 Net income.................... 9,811 9,811 Common stock issued Dividend Reinvestment Plan... 2,517 13 58 71 Employee Stock Plan.......... 5,690 28 140 168 Stock dividend issued - Common stock - 5%, including cash paid in lieu of fractional shares........... 296,116 1,481 6,144 (7,649) (24) Cash dividends declared - Common stock................. (4,508) (4,508) Purchase of Treasury Stock (21,026 shares).............. (547) (547) Issuance of Treasury Stock Dividend Reinvestment Plan (8,435 shares)............... (3) 247 244 Employee Stock Plan (2,819 shares)............... (1) 77 76 Change in net unrealized gain on available-for-sale securities, net of taxes...... (21) (21) --------- -------- -------- -------- ---------- ------- ------- Balance, December 31, 1996....6,237,009 $ 31,185 $ 16,325 $ 20,502 $ 1,603 $ (436) $69,179 ========= ======== ======== ======== ========== ======= =======
See accompanying notes to financial statements Consolidated Statements of Cash Flows Sterling Financial Corporation and Subsidiaries For the years ended December 31, (Dollars in thousands) 1996 1995 1994 Cash Flows from Operating Activities Net Income...........................................$ 9,811 $ 8,994 $ 8,277 Adjustments to reconcile net income to net cash provided by/(used in) operating activities: Depreciation...................................... 1,625 1,198 1,014 Accretion & amortization of investment securities. 356 367 661 Provision for possible loan losses................ 580 534 1,081 Provision for deferred income taxes............... 824 579 307 (Gain) on sale of property and equipment.......... (2) (1) (2) (Gain) on sales of investment securities.......... (158) none none (Gain) on sale of mortgage loans.................. (262) (163) (279) Proceeds from sales of mortgage loans............. 33,480 16,283 24,284 Originations of mortgage loans held for sale...... (33,272) (16,558) (21,098) Change in operating assets and liabilities: (Increase) decrease in accrued interest receivable and prepaid expenses............................ 517 (2,825) (138) (Increase) in other assets....................... (6,583) (2,469) (3,341) Increase (decrease) in accrued interest payable and accrued expenses........................... (350) 1,915 324 Increase (decrease) in other liabilities........ 836 (753) (140) --------- --------- --------- Net cash provided by/(used in) operating activities.. 7,402 7,101 10,950 Cash Flows from Investing Activities Proceeds from interest-bearing deposits in other banks..................................... 1,023 1,052 45,226 Purchase of interest-bearing deposits in other banks. (1,643) (1,052) (45,209) Proceeds from sales of investment securities available-for-sale.................................. 670 none none Proceeds from maturities or calls of investment securities held-to-maturity.... .................... 37,508 30,095 31,435 Proceeds from maturities or calls of investment securities available-for-sale....................... 8,948 2,921 1,103 Purchases of investment securities held-to-maturity.. (9,791) (46,273) (54,338) Purchases of investment securities available-for-sale (19,310) (6,926) (1,972) Federal funds sold, net.............................. (14,800) (9,350) 12,350 Net loans and leases made to customers............... (48,080) (34,057) (33,904) Purchases of premises and equipment.................. (7,880) (5,681) (5,810) Proceeds from sale of premises and equipment......... 49 11 245 --------- --------- --------- Net cash provided by/(used in) investing activities.. (53,306) (69,260) (50,874) Cash Flows from Financing Activities Net increase in demand deposits, NOW and savings accounts................................... 12,013 32,041 7,013 Net increase in time deposits........................ 24,918 41,062 24,309 Net increrase (decrease) in interest-bearing demand notes issued to the U.S. Treasury................... 507 (680) (86) Proceeds from borrowings............................. 58,474 39,180 13,850 Repayments of borrowings............................. (49,563) (36,830) (14,088) Federal funds purchased, net......................... none (6,000) 6,000 Repayments of mortgages payable and capitalized lease liability.................................... none none (11) Proceeds from issuance of common stock............... 239 1,731 2,645 Cash dividends paid.................................. (4,508) (5,260) (3,386) Cash paid in lieu of fractional shares............... (24) none none Acquisition of treasury stock........................ (547) (1,252) (379) Proceeds from issuance of treasury stock............. 320 1,207 241 --------- --------- --------- Net cash provided by/(used in) financing activities.. 41,829 65,199 36,108 --------- --------- --------- Increase (decrease) in cash and due from banks....... (4,075) 3,040 (3,816) Cash and due from banks: Beginning............................................ 35,414 32,374 36,190 --------- --------- --------- Ending...............................................$ 31,339 $ 35,414 $ 32,374 ========= ========= ========= Supplemental Disclosure of Cash Flow Information: Cash payments for: Interest paid to depositors and on borrowed money..$ 22,637 $ 19,937 $ 14,728 Income taxes....................................... 2,230 2,526 2,160 Supplemental Schedule of Noncash Investing and Financing Activities: Other real estate acquired in settlement of loans....$ 119 $ 293 $ 630
See accompanying notes to financial statements NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Sterling Financial Corporation and Subsidiaries (All dollar amounts presented in the tables are in thousands, except per share data) Note 1 - Formation of Sterling Financial Corporation As a result of a plan of reorganization, The First National Bank of Lancaster County, now by name change, Bank of Lancaster County, N.A. (Bank), became the wholly owned subsidiary of Sterling Financial Corporation (Parent Company), a new bank holding company, at the close of business June 30, 1987. Each outstanding share of the Bank's common stock (par value $10.00) was converted into two shares of common stock (par value $5.00) of the Parent Company. The authorized capital of the Parent Company is 35,000,000 shares of common stock. Note 2 - Summary of Significant Accounting Policies Business - Sterling Financial Corporation, through its subsidiary bank, Bank of Lancaster County, N.A., and its subsidiary, Town & Country, Inc., provides a full range of banking services to individual and corporate customers. The principal market area is Lancaster County, Pennsylvania. Sterling Financial Corpoation and the Bank of Lancaster County, N.A. are subject to competition from other financial institutions. Both are subject to regulations of certain federal agencies and, accordingly, they are periodically examined by those regulatory authorities. Basis of Financial Statement Presentation - The accounting and reporting policies of Sterling Financial Corporation and its subsidiaries (the Corporation) conform to generally accepted accounting principles and to general practices within the banking industry. In preparing the financial statements, management is required to make estimates and assumptions that affect the reported amounts of assets and liabilities as of the date of the balance sheet and revenues and expenses for the period. Actual results could differ significantly from these estimates. Principles of Consolidation - The accompanying consolidated financial statements include the accounts of Sterling Financial Corporation and its wholly owned subsidiaries, Bank of Lancaster County, N.A. and its subsidiary Town & Country, Inc., and Sterling Mortgage Services, Inc. (presently inactive). All significant intercompany transactions have been eliminated in the consolidation. Investment Securities - Investment securities include both debt securities and equity securities. Sterling adopted Statement of Financial Accounting Standards Board Statement No. 115 (SFAS 115), "Accounting for Certain Investments in Debt and Equity Securities" as of January 1, 1994. SFAS 115 addresses the accounting and reporting for investments in equity securities that have readily determinable fair values and for all investments in debt securities. These investments are to be classified in one of three categories and accounted for as follows: 1) debt securities that a company has the positive intent and ability to hold to maturity are classified as held-to-maturity securities and reported at amortized cost; 2) debt and equity securities that are bought and held principally for the purpose of selling them in the near term are classified as trading securities and reported at fair value with unrealized gains and losses included in earnings; and 3) debt and equity securities not classified as either held-to-maturity or trading securities are classified as available-for-sale securities and reported at fair value, with unrealized gains and losses excluded from earnings and reported as a separate component of stockholders' equity. Sterling has segregated its investment securities into two categories: those held-to-maturity and those available-for-sale. In 1995, the Financial Accounting Standards Board (FASB) issued a Special Report, "A Guide to Implementation of Statement 115 on Accounting for Certain Investments in Debt and Equity Securities." Effective November 15, 1995, the FASB permitted a one-time opportunity for institutions to reassess the appropriateness of the designations of all securities held upon the initial application of the Special Report. After a reassessment of the current designations of the portfolio, it was determined that an additional $54,218,000 in securities be transferred from the held-to-maturity category to available- for-sale category. Investment securities in the held-to-maturity category are carried at cost adjusted for amortization of premiums and accretion of discounts, both computed on the constant yield method. It is management's intent to hold investment account securities until maturity. However, the investment portfolio does serve as an ultimate source of liquidity. In order to acknowledge this function, Sterling has designated certain specific debt securities as being available-for- sale. Premiums and discounts are recognized in interest income computed on the constant yield method. All marketable equity securities are classified as available-for-sale. Realized gains and losses on securities are computed using the specific identification method and are included in Other Operating Income in the Consolidated Statements of Income. Future purchases of securities will be evaluated on an individual basis for classification among the three permissible categories based on management's intent and the ability to hold each security to maturity, on the relative sizes of the security categories in relation to future liquidity needs, on current asset/liability management strategies and other criteria as appropriate. Premises and Equipment - Premises, furniture and equipment, leasehold improvements, and capitalized leases are stated at cost, less accumulated depreciation and amortization. For book purposes, depreciation is computed primarily by using the straight-line method over the estimated useful life of the asset. Charges for maintenance and repairs are expensed as incurred. Gains and losses on dispositions are reflected in current operations. Other Real Estate Owned - Other real estate owned is carried at the lower of cost or an amount not in excess of estimated fair value. Allowance for Loan Losses - The provision for loan losses charged to operating expense reflects the amount deemed appropriate by management to produce an adequate reserve to meet the present and foreseeable risk characteristics of the loan portfolio. Management's judgement is based on the evaluation of individual loans and their overall risk characteristics, past loan loss experience, and other relevant factors. Loan losses are charged directly against the allowance and recoveries on previously charged-off loans are added to the allowance. Interest Income - Interest on installment loans is recognized primarily on the simple interest, actuarial and the rule of seventy-eights methods. Interest on other loans is recognized based upon the principal amount outstanding. The general policy has been to cease accruing interest on loans when it is determined that a reasonable doubt exists as to the collectibility of additional interest. Interest income on these loans is only recognized to the extent payments are received. Loan Origination Fees and Costs - Loan fees, net of loan origination costs, are deferred and amortized to interest income over the life of the loan. The amortization of net deferred fees is discontinued on non-accrual loans. Federal Income Taxes - Applicable income taxes are based on income as reported in the consolidated financial statements. Deferred income taxes are provided for those elements of income and expense which are recognized in different periods for financial reporting and income tax purposes. Trust Department Assets and Income - Trust assets held by the Bank in a fiduciary or agency capacity for customers of the Trust Department are not included in the financial statements since such items are not assets of the Bank. Trust income has been recognized on the cash basis which is not significantly different from amounts that would have been recognized on the accrual basis. Earnings per Share - Earnings per common share were computed by dividing net income by the weighted average number of shares of common stock outstanding which were 6,235,257, 6,204,212 and 6,128,058 for 1996, 1995 and 1994 respectively, after giving retroactive effect to a 5% stock dividend paid in July 1996 and a two-for-one stock split in the form of a 100% stock dividend paid in 1994. Presentation of Cash Flows - For purposes of reporting cash flows, cash and due from banks includes cash on hand and amounts due from banks (including cash items in process of clearing). Reclassifications - Certain income items for prior years have been reclassified in order to conform with the current year presentation with no effect to net income. Accounting for Mortgage Servicing Rights - FASB Statement No. 122, "Accounting for Mortgage Servicing Rights - an amendment of FASB Statement No. 65", effective for fiscal years beginning after December 15, 1995, establishes accounting standards for recognizing servicing rights on mortgage loans. The Corporation has historically originated mortgage loans as a normal business activity, selling the mortgages on the secondary market to Federal Home Loan Mortgage Corporation and retaining all mortgage servicing. Mortgage sale income has been recorded on a "net" gain/loss basis. FASB No. 122 will require recognition of servicing "value" as an asset and immediate income as though mortgage servicing has been sold rather than retained. The servicing asset valuation will be amortized over the expected servicing life of the mortgage portfolio. In addition, the mortgage servicing asset must be valued periodically for impairment, based upon review of expected servicing life in relation to current market rates. The implementation of FASB No. 122 will result in a greater recognition of income from mortgage origination and sales activity and a corresponding decrease of servicing income over the serviced mortgage portfolio life. In June 1996, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 125 - "Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities". This Statement amends and extends to all servicing assets and liabilities the accounting standards for mortgage servicing rights now in FASB Statement No. 65, "Accounting for Certain Mortgage Banking Activities", and supercedes FASB Statement No. 122, "Accounting for Mortgage Servicing Rights". This Statement is effective for transfers and servicing of financial assets and extinguishments of liabilities occurring after December 31, 1996, and is to be applied prospectively. Sterling has determined that the application of this Standard will not have a material effect on earnings. The FASB also subsequently issued FASB No. 127 that delayed until January 1, 1998, the effective date of certain provisions of FASB 125. Transactions subject to the later effective date include securities lending, repurchase agreements, dollar-rolls and similar secured financing arrangements. Application of the new rules is not expected to have a material impact on Sterling's consolidated financial statements. Mortgage Loans Held for Sale - Mortgage loans held for sale are recorded at the lesser of current secondary market value or the actual book value of loans. Note 3 - Restrictions on Cash and Due From Banks The Bank is required to maintain average reserve balances with the Federal Reserve Bank. The average amount of these reserve balances for the year ended December 31, 1996 was approximately $7,776,000. Balances maintained at the Federal Reserve Bank are included in cash and due from banks. Note 4 - Investment Securities As discussed in Note 2, the Corporation adopted SFAS 115 effective January 1, 1994. A one-time move from the held-to-maturity category to the available- for-sale category was permitted during 1995. The Corporation took advantage of this opportunity and moved a total of $54,218,000 from the held-to-maturity category to the available-for-sale category. The amount of net unrealized gain on securities available-for-sale, net of taxes, transferred to stockholders' equity amounted to $510,295 on this transfer. Securities pledged to secure government and other public deposits, trust deposits, short-term borrowings, and other balances as required or permitted by law were carried at $47,763,546 in 1996 and $54,780,570 in 1995. The amortized cost and fair values of investment securities held-to- maturity are as follows:
December 31, 1996 Gross Gross Amortized Unrealized Unrealized Fair Cost Gains Losses Value U.S. Treasury securities............$ 12,888 $ 42 $ 32 $ 12,898 Obligations of other U.S. Government agencies and corporations......... 11,607 35 77 11,565 Obligations of states and political subdivisions...................... 37,584 560 169 37,975 Mortgage-backed securities.......... 2,076 108 1 2,183 Other bonds, notes and debentures... 27,269 154 64 27,359 ---------- --------- -------- -------- Subtotal............................ 91,424 899 343 91,980 Nonmarketable equity securities..... 2,798 none none 2,798 ---------- ---------- --------- -------- Total...............................$ 94,222 $ 899 $ 343 $ 94,778 =========== ========== ========= ======== December 31, 1995 Gross Gross Amortized Unrealized Unrealized Fair Cost Gains Losses Value U.S. Treasury securities............$ 18,837 $ 158 $ 69 $ 18,926 Obligations of other U.S. Government agencies and corporations......... 18,473 110 65 18,518 Obligations of states and political subdivisions...................... 40,212 796 154 40,854 Mortgage-backed securities.......... 3,854 152 1 4,005 Other bonds, notes and debentures... 38,944 362 108 39,198 ---------- --------- --------- -------- Subtotal............................ 120,320 1,578 397 121,501 Nonmarketable equity securities..... 2,565 none none 2,565 ---------- --------- --------- -------- Total...............................$ 122,885 $ 1,578 $ 397 $ 124,066 ========== ========= ========= ========
Included in nonmarketable equity securities is Federal Reserve stock, Federal Home Loan Bank of Pittsburgh stock and Atlantic Central Bankers Bank stock. The amortized cost and fair values of held-to-maturity debt securities at December 31, 1996, by contractual maturity, are shown below. Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties. December 31, 1996 Amortized Fair Cost Value Due in one year or less................$ 23,864 $ 23,918 Due after one year through five years.. 42,771 42,954 Due after five years through ten years. 17,507 17,723 Due after ten years.................... 5,206 5,202 ----------- ----------- 89,348 89,797 Mortgage-backed securities............. 2,076 2,183 ----------- ----------- $ 91,424 $ 91,980 =========== =========== The amortized cost and fair values of investment securities available- for-sale are as follows:
December 31, 1996 Gross Gross Amortized Unrealized Unrealized Fair Cost Gains Losses Value U.S. Treasury securities............$ 13,611 $ 60 $ 73 $ 13,598 Obligations of other U.S. Government agencies and corporations......... 18,800 63 145 18,718 Obligations of states and political subdivisions...................... 20,488 400 69 20,819 Mortgage-backed securities.......... 1,125 1 9 1,117 Other bonds, notes and debentures... 22,752 129 110 22,771 ---------- --------- -------- -------- Subtotal............................ 76,776 653 406 77,023 Equity securities and corporate stock............................. 171 2,181 none 2,352 ---------- ---------- --------- -------- Total...............................$ 76,947 $ 2,834 $ 406 $ 79,375 =========== ========== ========= ======== December 31, 1995 Gross Gross Amortized Unrealized Unrealized Fair Cost Gains Losses Value U.S. Treasury securities..............$ 11,046 $ 148 $ 40 $ 11,154 Obligations of other U.S. Government agencies and Corporations............ 15,489 180 37 15,632 Obligations of states and political subdivisions......................... 19,622 455 132 19,945 Mortgage-backed securities............ 1,249 4 11 1,242 Other bonds, notes and debentures..... 19,013 301 67 19,247 -------- ------- ------ -------- Subtotal.............................. 66,419 1,088 287 67,220 Equity securities and corporate stock............................... 88 1,659 none 1,747 -------- ------- ------ -------- Total.................................$ 66,507 $ 2,747 $ 287 $ 68,967 ======== ======= ====== ========
The amortized cost and fair values of available-for-sale debt securities at December 31, 1996 by contractual maturity, are shown below. Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties. December 31, 1996 Amortized Fair Cost Value Due in one year or less...................$ 2,567 $ 2,568 Due after one year through five years..... 49,441 49,416 Due after five years through ten years.... 19,215 19,464 Due after ten years....................... 4,428 4,458 -------- -------- 75,651 75,906 Mortgage-backed securities................ 1,125 1,117 -------- -------- $ 76,776 $ 77,023 ======== ======== Proceeds from sales of investment securities available-for-sale during 1996 were $670,095. Gains of $158,373 were realized on these sales. There were no sales of investment securities during 1995 or 1994. Note 5 - Loans Loans outstanding at December 31, are as follows:
1996 1995 Commercial, financial and agricultural.....................$ 239,701 $ 228,058 Real estate - construction................................. 5,608 6,378 Real estate - mortgage..................................... 45,373 33,124 Consumer................................................... 136,989 116,210 Lease financing receivables (net of unearned income)....... 47,346 43,904 ------------ ------------ Total loans, gross.........................................$ 475,017 $ 427,674 ============ ============
Loans on a non-accrual status amounted to $1,193,000 at December 31, 1996, compared to $1,010,000 at December 31, 1995. If interest income had been recorded on all such loans for the years indicated, such interest income would have increased by approximately $116,567 and $143,997 for 1996 and 1995 respectively. SFAS No. 118, "Accounting by Creditors for Impairment of a Loan - Income Recognition and Disclosures", an amendment of SFAS No. 114, was implemented at the beginning of 1995. The Bank has defined impaired loans as all loans on nonaccrual status, except those specifically excluded from the scope of SFAS No. 114, regardless of the credit grade assigned by loan review. All impaired loans were measured by utilizing the fair value of the collateral for each loan. When the measure of an impaired loan is less than the recorded investment in the loan, the Bank will compare the impairment to the existing allowance assigned to the loan. If the impairment is greater than the allowance, the Bank will adjust the existing allowance to reflect the greater amount or take a corresponding charge to the provision for loan losses. If the impairment is less than the existing allowance for a particular loan, no adjustments to the allowance or the provision for loan and lease losses will be made. There was no adjustment necessary for the impaired loans for the periods indicated. The average amount of nonaccruals for the fourth quarter of 1996 was $1,171,599 compared to $1,112,405 for the fourth quarter 1995, while the average for the year 1996 was $1,119,305 compared to $1,746,100 for 1995. The following table presents information concerning impaired loans at December 31: 1996 1995 Gross impaired loans which have allowances..........$ 1,193 $1,010 Less: Related allowances for loan losses......... (179) (349) ------- ------ Net impaired loans..................................$ 1,014 $ 661 ======= ====== Note 6 - Allowance for Loan Losses Changes in the Allowance for Loan Losses were as follows:
1996 1995 1994 Balance at January 1..................................$ 7,780 $ 7,640 $ 7,180 Recoveries credited to allowance...................... 143 282 141 Provisions for loan losses charged to income.......... 580 534 1,081 -------- -------- -------- Total................................................. 8,503 8,456 8,402 Losses charged to allowance........................... 703 676 762 -------- -------- -------- Balance at December 31................................$ 7,800 $ 7,780 $ 7,640 ========= ======== ======== Ratio of Allowance to loans, net of unearned income at end of year..................................... 1.65% 1.82% 1.95%
Note 7 - Premises and Equipment Premises and equipment at December 31, 1996 and 1995 is summarized as follows: 1996 1995 Land.............................................$ 3,756 $ 2,482 Buildings........................................ 16,603 11,814 Buildings under capitalized lease................ 104 104 Leasehold improvements........................... 813 735 Equipment, furniture and fixtures................ 11,553 10,597 Construction in progress......................... 430 14 ---------- ---------- 33,259 25,746 Less: Accumulated depreciation................... (10,601) (9,296) ---------- ---------- $ 22,658 $ 16,450 ========== ========== Contributing to the increase in premises and equipment was the cost of a building to be utilized as an operations and administrative service center, as well as furniture and equipment for this building. Depreciation expense amounted to $1,625,184 in 1996, $1,197,980 in 1995 and $1,013,830 in 1994. Note 8 - Other Assets Included in other assets for 1996 and 1995 is $26,533,442 and $22,990,784 respectively which represents operating leases generated by Town & Country, Inc. The income generated from the leases for 1996 and 1995 amounted to $2,647,810 and $2,211,700 respectively and is reflected in other operating income. The following schedule provides an analysis of Town & Country's investment in property on operating leases and property held for lease by major classes as of December 31, 1996 and 1995: 1996 1995 Construction equipment...........$ 400 $ 688 Transportation equipment......... 14,604 12,018 Automobiles...................... 17,218 14,265 Manufacturing equipment.......... 961 5,550 Trucks........................... 14,956 12,614 Other............................ 4,028 734 ---------- ----------- Total............................ 52,167 45,869 Less: Accumulated depreciation... (25,634) (22,878) ---------- ----------- $ 26,533 $ 22,991 ========== =========== The following is a schedule by years of minimum future rentals on noncancelable operating leases as of December 31, 1996: Year ending December 31: 1997...............................$ 13,118 1998................................ 1,995 1999................................ 382 2000................................ 213 2001................................ 189 ------- Total minimum future rentals.......$ 15,897 ======= Also included in other assets is mortgage servicing rights activity. The activity for the year ended December 31, 1996 is as follows: 1996 Balance at beginning of year..........$ none Capitalized mortgage servicing rights. 471 Amortization.......................... (29) ------- Balance at end of year................$ 442 ======= The Corporation adopted, effective January 1, 1996, Statement of Financial Accounting Standards (SFAS) No. 122, "Accounting for Mortgage Servicing Rights", an ammendment of FASB Statement No. 65. In June 1996, the Financial Accounting Standards Board (FASB) issued SFAS No. 125, "Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities". The Statement amends and extends to all servicing assets and liabilities the accounting standards for mortgage servicing rights now in FASB Statement No. 65, "Accounting for Certain Mortgage Banking Activities", and supercedes SFAS No. 122. This Statement requires that servicing assets and liabilities be subsequently measured by (a) amortization in proporation to and over the period of estimated net servicing income or loss and (b) assessment for asset impairment or increased obligation based on their fair values. A valuation allowance will be recorded if the unamortized mortgage servicing rights exceed their fair value. There was no valuation allowance for servicing rights for the year ended December 31, 1996. Mortgage servicing rights are a result of originated mortgages. There have been no mortgage servicing rights purchased. Note 9 - Time Certificates of Deposit At December 31, 1996 and 1995, time certificates of deposit of $100,000 or more aggregated $26,196,721 and $22,938,324 respectively. Note 10 - Short-Term Borrowings and Other Liabilities for Borrowed Money The Bank maintains lines of credit with various correspondent banks to use as sources of short-term funds. Federal funds purchased, borrowings from the Federal Reserve Bank and interest-bearing demand notes issued to the U.S. Treasury would be considered short-term borrowings. There were no federal funds purchased or borrowings from the Federal Reserve Bank at December 31, 1996 or 1995. Interest-bearing demand notes issued to U.S. Treasury were $2,741,000 and $2,234,000 for 1996 and 1995 respectively. In addition, the Bank maintains a line of credit with the Federal Home Loan Bank of Pittsburgh. Based on the amount of the Federal Home Loan Bank stock owned by the Bank, the maximum borrowing capacity at December 31, 1996 was $15,910,000. There were no advances from the Federal Home Loan Bank considered as short-term borrowings at December 31, 1996 or 1995. The average balance outstanding for any category of short-term borrowings during the periods reported was less than 30 per cent of stockholders' equity at the end of each period reported. The following represents other liabilities for borrowed money at December 31:
1996 1995 Notes payable-Town & Country, Inc.(Subsidiary of Bank) borrowings from various lenders for leasing operations......$28,423 $19,283 Federal Home Loan Bank advances............................... 2,011 2,240 ------ ------ Total.........................................................$30,434 $21,523 ====== ======
Liabilities in connection with Town & Country, Inc. leasing operations are payable to various lenders at various terms. The estimated current portion of this debt is $14,817,345 at December 31, 1996. The borrowings from the Federal Home Loan Bank of Pittsburgh, which total $2,010,547, consist of three advances. An advance in 1993 in the amount of $950,000 carries an interest rate of 5.39% per year and matures September 13, 2000. In 1995 an advance was obtained in the amount of $668,700, at a rate of 6.41% per year and matures September 28, 2001. In 1996, $400,000 was advanced at the rate of 3% per year and matures March 7, 2011. The balance on this obligation at December 31, 1996 was $391,847. Note 11 - Pension and Employee Stock Bonus Plan The Bank of Lancaster County, N.A. and its subsidiary, Town & Country, Inc. maintains a qualified non-contributory pension plan for their employees. The Plan specifies fixed benefits to provide a monthly pension benefit at age 65 for life equal to one and one-half percent of each participant's final average salary (highest five consecutive years' base compensation preceding retirement) for each year of credited service. Salary in excess of $150,000 (effective in the year 1994) is disregarded in determining a participant's retirement benefit pursuant to IRS regulations. All employees with one year of service who work at least 1,000 hours per year and who are at least age 21 are eligible to participate. A participant becomes 100% vested upon completion of five years with a vesting credit. Net periodic pension cost for 1996, 1995 and 1994 included the following: 1996 1995 1994 Service cost....................... $ 614 $ 579 $ 577 Interest cost...................... 567 504 428 Return on Plan assets..............(1,049) (950) 6 Net amortization and deferral...... 368 417 (463) ------ ------ ------ Net periodic pension cost..........$ 500 $ 550 $ 548 ====== ====== ====== The following table sets forth the Plan's funded status at December 31, 1996, 1995 and 1994:
Actuarial present value of benefit obligations: 1996 1995 1994 Accumulated benefit obligation, including vested benefits of $5,499,101 for 1996, $5,238,774 for 1995 and $3,705,229 for 1994..................................$ 5,551 $ 5,275 $ 3,745 ======= ======= ======= Projected benefit obligation for service rendered to date......................................................$(8,451) $(8,143) $(6,890) Plan assets at fair value.. ............................... 8,265 6,728 6,087 ------- ------- ------- Projected plan assets in excess of or (less than) benefit obligation........................................$ (186) $(1,415) $ (803) Unrecognized net (gain) or loss from past experience different from that assumed and effects of changes in assumptions............................................ 449 1,495 1,374 Unrecognized net (asset) or obligation..................... (207) (276) (345) Unrecognized prior service cost............................ (120) (128) none ------- ------- ------- Prepaid (accrued) pension cost included in other assets (liabilities).............................$ (64) $ (324) $ 226 ======= ======= =======
The weighted-average discount rate and rate of increase in future compensation levels used in determining the actuarial present value of the projected benefit obligation were 7.25% and 5.25%, respectively, at December 31, 1996. The expected long-term rate of return on plan assets in 1996 was 9%. The Board of Directors of the Bank adopted an employee stock plan effective July 1, 1981. The assets of the Plan will be entirely invested in Sterling Financial Corporation common stock. The Plan covers all Bank employees who are age 18 and over, are employed for at least 1,000 hours per year and have completed at least one year of service. The Plan has two parts: *The salary deferral portion of the Plan permits any eligible participant to make voluntary contributions to the Plan ranging from 2% to 6% of compensation. The Bank will contribute 25% of what the participant contributes. Effective January 1, 1997, the Plan was amended to allow employees to make voluntary contributions up to a maximum of 10% of total compensation. The provision for the matching contribution remains the same, with the Bank contributing 25% of each participant's contribution up to 6%. This portion of the Plan is intended to encourage thrift and investment in Sterling Financial Corporation stock, as well as supplement their retirement. The Plan allows for employees to make their voluntary contributions on a pre-federal income tax basis. *The performance incentive portion of the Plan allows the Bank to make annual contributions to the Plan based on certain overall Bank performance objectives. These contributions will be allocated to the participants based on compensation. Bank contributions to the Plan vest in each participant's account at the rate of 20% for each year of service. Normally, benefits may be paid from the Plan on retirement, termination, disability or death. Participants in the Plan may withdraw their own contribution earlier under several restricted conditions of hardship with approval of the Plan Committee. The Plan provides that each participant may vote the shares in his or her account through the Plan Trustee at any shareholder meeting. The Bank of Lancaster County Trust Department serves as Trustee for the Plan. All dividends received on Sterling Financial Corporation stock are reinvested in additional shares of Sterling Financial Corporation stock. The contribution to the performance incentive portion of the Plan was $235,000, $216,000 and $200,000 for 1996, 1995 and 1994 respectively. The contribution to the salary deferral portion of the Plan was $75,619 in 1996, $65,946 in 1995 and $51,305 in 1994. Effective January 1, 1993, Sterling adopted Statement of Financial Accounting Standards No. 106 - "Employers' Accounting for Postretirement Benefits Other Than Pensions". Under SFAS No. 106, the cost of postretirement benefits other than pensions must be recognized on an accrual basis as employees perform services to earn the benefits. This is a significant change from the previous generally accepted practice of accounting for these benefits which was on a cash basis. The accumulated postretirement benefit obligation at the date of adoption (the "transition obligation") could have been recognized in operations as the cumulative effect of an accounting change in the period of adoption, which would have resulted in an actuarially determined pre-tax charge to earnings of $1,026,457, or its recognition could be delayed by amortizing the obligation over future periods as a component of the postretirement benefit cost. Sterling adopted SFAS No. 106 by recognizing the transition on a delayed basis. The transition obligation in the amount of $1,026,457 is being amortized on a straight-line basis over a 20 year period which is the average remaining service period of active plan participants. The cost for postretirement benefits other than pensions consisted of the following components at December 31, 1996, 1995 and 1994: 1996 1995 1994 Service cost......................$ 96 $ 93 $ 93 Interest cost..................... 100 99 87 Amortization of unrecognized transition obligation........... 51 51 51 ----- ----- ----- Net periodic postretirement benefit cost................. $247 $243 $231 ==== ==== ==== Sterling's postretirement benefits other than pensions are currently not funded. The status of the plans at December 31, 1996, 1995 and 1994 is as follows: Actuarial valuation of accumulated postretirement benefit obligation: 1996 1995 1994 Retirees..................................$ 319 $ 324 $ 289 Fully eligible active plan participants... 290 323 258 Other active plan participants............ 601 787 786 ----- ----- ----- $1,210 $1,434 $1,333 Unrecognized transition obligation........ (821) (872) (924) Unrecognized prior service cost........... 251 none none Unrecognized net gain (loss).............. 195 56 (9) ----- ----- ----- Accrued postretirement benefit cost....... $ 835 $ 618 $ 400 ===== ===== ===== Prior to January 1, 1993, Sterling recognized the cost of postretirement benefits, which is primarily retiree health care, as an expense as premiums were incurred. The postretirement health care plan is contributory, with retiree contributions based on years of service. The assumed postretirement health care cost trend rate used in measuring the accumulated postretirement benefit was 7.75% in 1996, decreasing by .5% per year to an ultimate rate of 5.25% in 2001 and remains at that level thereafter. The discount rate used to measure the accumulated postretirement benefit obligation was 7.25% in 1996. The health care cost trend rate assumption has a significant effect on the amounts reported. To illustrate, increasing the assumed health care cost trend rates by one percentage point in each year would increase the accumulated postretirement benefit obligation as of December 31, 1996 by $250,304 and the aggregate of the service and interest cost components of net periodic postretirement benefit cost for the year ended December 31, 1996 by $52,861. The Board of Directors of the Bank adopted a Retirement Restoration Plan during 1996 for any officer whose compensation exceeded $150,000. The Plan was designed to "restore" the level of benefits which is lost to these employees under the organization's qualified retirement plans because of Internal Revenue Code restrictions. The Plan is designed to mirror the provisions set forth in the qualified retirement plans available to all Bank of Lancaster County employees -- the defined benefit pension plan, and the employee stock or 401(k) plan. The Plan allows for the calculation of benefits on the officer's salary in excess of $150,000. The effective date of the Plan was May 1, 1996. The net periodic pension cost for the Retirement Restoration Plan for 1996 included the following: 1996 ---- Service cost.....................................$ 8 Interest cost.................................... 9 Amortization of unrecognized prior service cost.. 13 ------ Net periodic pension cost........................$ 30 ====== Actuarial valuation of accumulated benefit obligation: 1996 ---- Eligible Participant............................$ 48 Intangible asset................................ (18) ------- Accrued retirement restoration plan liability...$ 30 ======= Note 12 - Applicable Income Taxes The effective income tax rates for financial reporting purposes are less than the Federal statutory rate of 34% for 1996, 1995 and 1994 for reasons shown as follows:
For the years ended December 31, Statutory Statutory Statutory 1996 Rate 1995 Rate 1994 Rate Federal income tax expense at statutory rate............$ 4,406 34.0% $ 4,091 34.0% $ 3,711 34.0% Reduction resulting from: Non-taxable interest income... (1,153) (8.9%) (1,046) (8.7%) (966) (8.8%) Other, net.................... (186) (1.4%) (71) (.6%) (149) (1.4%) ------- ------ ------- ------ ------- ------ Applicable Federal income taxes.$ 3,067 23.7% $ 2,974 24.7% $ 2,596 23.8% State income taxes.............. 80 .6% 65 .6% 41 .4% ------- ------ ------- ------ ------- ------ Applicable income taxes.........$ 3,147 24.3% $ 3,039 25.3% $ 2,637 24.2% ======= ====== ======= ====== ======= ====== Taxes currently payable.........$ 2,323 $ 2,460 $ 2,330 Deferred income taxes........... 824 579 307 ------- ------- ------- Applicable income taxes.........$ 3,147 $ 3,039 $ 2,637 ======= ======= =======
The Corporation had net deferred tax credits of $4,326,000, $3,512,000 and $2,312,000 at December 31, 1996, 1995 and 1994 respectively. The tax effect of temporary differences that gave rise to significant portions of the net deferred tax liability at December 31, 1996 and 1995, are as follows:
December 31, 1996 1995 ---- ---- Deferred tax assets: Allowance for loan losses.....................$ 2,763 $ 2,756 Deferred loan fees and costs.................. 43 57 Postretirement benefits other than pensions... 292 216 Foreclosed assets............................. 7 11 Pension....................................... 47 0 Other......................................... 38 15 ------- ------- Total deferred tax assets...................$ 3,190 $ 3,055 ======= ======= Deferred tax liabilities: Leasing...................................... $(6,375) $(5,321) Depreciation.................................. (294) (244) Pension....................................... (0) (145) Unrealized gains on investments............... (826) (836) Other......................................... (21) (21) ------- ------- Total deferred tax liabilities..............$(7,516) $(6,567) ======= ======= Net deferred tax liability..................$(4,326) $(3,512) ======= =======
Amounts for the current year are based upon estimates and assumptions as of the date of this report and could vary from amounts shown on the tax return when filed. Accordingly, amounts previously reported for 1995 may change as a result of adjustments to conform to tax returns filed. The Financial Accounting Standards Board has issued Statement No. 109, "Accounting for Income Taxes", which significantly changes the recognition and measurement of deferred income tax assets and liabilities. Statement No. 109 requires that deferred income taxes be recorded on an asset/liability method and adjusted when new tax rates are enacted. The corporation adopted Statement No. 109 beginning with its year ending December 31, 1993. The Statement provides that the effect of its adoption may be recorded entirely in the year of adoption or retroactively by restating one or more prior years. The statement was retroactively applied to 1990. Note 13 - Stock Options On November 19, 1996, the Board of Directors of the Corporation adopted the Sterling Financial Corporation 1996 Stock Incentive Plan (the "Stock Incentive Plan") which will be submitted to the shareholders of this Corporation for their approval and ratification at the 1997 Annual Meeting of Shareholders. The stated purpose of the Stock Incentive Plan is to advance the development, growth and financial condition of the Corporation. The Stock Incentive Plan provides for the issuance of shares of the Corporation's Common Stock to the Corporation's employees. The shares of Common Stock that may be issued under the Stock Incentive Plan shall not exceed in the aggregate 500,000 shares of Common Stock. The Stock Incentive Plan is administered by a disinterested committee of the Corporation's Board of Directors. Incentive awards can be made in the form of incentive stock options, nonqualified stock options, stock appreciation rights or restricted stock as the disinterested committee deems appropriate. There were 32,850 options granted, pending shareholder approval, during 1996; no options were exercised during 1996, or as of the record date, March 14, 1997. Sterling has elected to follow Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees" (APB 25) and related interpretations in accounting for its employee stock options because the alternative fair value accounting provided for under FASB Statement No. 123, "Accounting for Stock- Based Compensation", requires use of option valuation models that were not developed for use in valuing employee stock options. Under APB 25, because the exercise price of Sterling's employee stock options equals the market price of the underlying stock on the date of the grant, no compensation expense is recognized. Note 14 - Operating Leases The Bank leases certain banking facilities under operating leases which expire on various dates to 2022. Renewal options are available on these leases. Minimum future rental payments as of December 31, 1996 are as follows: Operating Leases 1997.........................$ 565 1998......................... 531 1999......................... 474 2000......................... 299 2001......................... 242 Later years.................. 1,888 ------- Total minimum future rental payments...................$ 3,999 ======= Total rent expense charged to operations amounted to $562,547 in 1996, $479,809 in 1995 and $413,996 in 1994. Note 15 - Disclosures about Fair Value of Financial Instruments The following methods and assumptions were used to estimate the fair value of each class of financial instruments for which it is practicable to estimate that value. Cash and Short-Term Investments - For those short-term instruments, the carrying amount is a reasonable estimate of fair value. Investment Securities - For investment securities, fair value equals quoted market price, if available. If a quoted market price is not available, fair value is estimated using quoted market prices for similar securities. Loans - For certain homogenous categories of loans, such as some residential mortgages, fair value is estimated using the quoted market prices for securities backed by similar loans, adjusted for differences in loan characteristics. The fair value of other types of loans is estimated by discounting the future cash flows using the current rates at which similar loans would be made to borrowers with similar credit ratings and for the same remaining maturities. Lease contracts as defined in FASB Statement No. 13, "Accounting for Leases", are not included in this disclosure statement. Deposit Liabilities - The fair value of demand deposits, savings accounts and certain money market deposits is the amount payable on demand at the reporting date. The fair value of fixed-maturity certificates of deposits is estimated using the rates currently offered for deposits of similar remaining maturities. Federal Funds Purchased - The carrying amount of federal funds purchased approximates its fair value due to the overnight maturities of these financial instruments. U.S. Treasury Demand Notes - For U.S. Treasury demand notes, the carrying amount is a reasonable estimate of fair value. Other Borrowings - Rates currently available to the Company for debt with similar terms and remaining maturities are used to estimate fair value of existing debt. Commitments to Extend Credit and Standby Letters of Credit - The fair value of commitments is estimated using the fees currently charged to enter into similar agreements, taking into account the remaining terms of the agreements and the present creditworthiness of the counterparties. For fixed-rate loan commitments, fair value also considers the difference between current levels of interest rates and committed rates. The fair value of guarantees and letters of credit is based on fees currently charged for similar agreements or on the estimated cost to terminate them or otherwise settle the obligations with the counterparties at the reporting date. The estimated fair values of the Corporation's financial instruments are as follows:
1996 1995 --------------------- -------------------- Carrying Fair Carrying Fair Amount Value Amount Value --------- --------- --------- --------- Financial Assets: Cash and short-term investments.....$ 31,983 $ 31,983 $ 35,438 $ 35,438 Investment securities held-to-maturity................. 94,222 94,778 122,885 124,066 Investment securities available-for-sale............... 79,375 79,375 68,967 68,967 Loans............................... 428,687 384,732 Less: Allowance for loan losses.... (7,180) (7,180) --------- --------- --------- --------- Net loans..........................$ 421,507 $ 421,936 $ 377,552 $ 380,131 Financial Liabilities: Deposits..........................$ 647,036 $ 649,315 $ 610,105 $ 612,611 U.S. Treasury demand notes........ 2,741 2,741 2,234 2,234 Other borrowings.................. 30,434 30,189 21,523 21,281 Unrecognized financial instruments:* Interest rate swaps: In a net receivable position.....$ none $ none $ none $ none In a net payable position........ (none) (none) (none) (none) Commitments to extend credit...... (82) (82) (72) (72) Standby letters of credit......... (48) (48) (38) (38) Financial guarantees written...... (none) (none) (none) (none)
* The amounts shown under "Carrying Amount" represent accruals or deferred income (fees) arising from those unrecognized financial instruments. Note 16 - Commitments and Contingent Liabilities In the normal course of business, there are various commitments and contingent liabilities which are not reflected in the financial statements. These include lawsuits and commitments to extend credit, guarantees and letters of credit. In the opinion of management, there are no material commitments which represent unusual risks. A summary of the more significant commitments as of December 31, 1996 and 1995 are as follows: Financial instruments whose contract amounts represent credit risk: 1996 1995 Standby letters of credit ....................$ 7,594 $ 7,568 Commitments to extend credit..................$ 80,259 $ 76,672 Standby letters of credit are obligations to make payments under certain conditions to meet contingencies related to customers' contractual agreements and are subject to the same risk, credit review and approval process as loans. Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require the payment of a fee. Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. Each customer's creditworthiness is evaluated on a case-by-case basis. Excluded from these amounts are commitments to extend credit in the form of retail credit cards, check credit or related plans. Sterling's exposure to credit loss in the event of non-performance by the other party to the financial instrument for commitments to extend credit and standby letters of credit is represented by the contractual notional amount of those instruments. Sterling uses the same credit policies in making commitments and conditional obligations as it does for on-balance sheet instruments. Most of Sterling's business activity is with customers located within Sterling's defined market area. Sterling grants commercial, residential and consumer loans throughout the market area. The loan portfolio is well diversified and Sterling does not have any significant concentrations of credit risk. In 1994, SFAS No. 119 - "Disclosure about Derivative Financial Instruments and Fair Value of Financial Instruments" was issued effective for financial statements issued after December 15, 1994. The Corporation has not entered into any derivatives defined as a future, forward, swap, option, caps, floors, etc. However, the financial instruments listed above as standby letters of credit and commitments to extend credit have characteristics similar to derivatives. The following is a schedule that represents the estimated risk of current interest rates versus committed rates. Due to the uncertainty of when and how much a commitment to extend credit will be exercised, estimates were used. Fixed Rate Commitments 1996 1995 Carrying value at December 31,..............$ 0 $ 0 Commitment available not yet exercised......$ 17,932 19,105 Commitment revalued at existing rates with estimated activity........................$ 17,932 19,117 Note 17 - Related Party Transactions Certain directors and officers of Sterling Financial Corporation and its subsidiaries, their immediate families and companies in which they are principal owners (more than 10%), were indebted to the Bank during 1996 and 1995. All loans were made on substantially the same terms, including interest rates and collateral, as those prevailing at the time for comparable transactions with other persons and, in the opinion of the management of the Bank, do not involve more than a normal risk of collectibility or present other unfavorable features. Total loans to these persons at December 31, 1996 and 1995 amounted to $5,435,443 and $6,170,667 respectively. During 1996, $1,585,700 of new loans were made and repayments totaled $2,320,924. Note 18 - Dividend and Loan Restrictions Dividends are paid by Sterling Financial Corporation from its assets which are provided in part by dividends from Bank of Lancaster County, N.A. However, certain restrictions exist regarding the ability of the Bank to transfer funds to Sterling Financial Corporation in the form of dividends. The approval of the Comptroller of the Currency shall be required if the total of all dividends declared by the Bank in any calendar year shall exceed the total of its net profits of that year combined with its retained net profits of the preceding two years. Under these restrictions, the Bank can declare dividends in 1997 without approval of the Comptroller of the Currency of approximately $10,312,000 plus an additional amount equal to the Bank's net profits for 1997 up to the date of any such dividend declaration. Under current Federal Reserve regulations, the Bank is limited in the amount it may loan to Sterling Financial Corporation. Loans to Sterling Financial Corporation may not exceed 10% of the Bank's capital stock and surplus. Note 19 - Sterling Financial Corporation (Parent Company Only) Financial Information
Condensed Balance Sheets As of December 31, 1996 1995 Assets Cash.......................................................$ 1,109 $ 5 Securities available-for-sale.............................. 185 88 Investment in subsidiaries at equity....................... 69,026 63,994 Other assets............................................... 51 847 -------- -------- Total Assets.................................................$ 70,371 $ 64,934 ======== ======== Liabilities Other liabilities..........................................$ 1,192 $ 1,025 Stockholders' Equity Common Stock...............................................$ 31,185 $ 29,663 Capital Surplus............................................ 16,325 9,987 Retained Earnings.......................................... 20,502 22,848 Net Unrealized Gain on securities available-for-sale, net of taxes........................................... 1,603 1,624 Less: Treasury Stock at cost............................... (436) (213) -------- -------- Total Stockholders' Equity...................................$ 69,179 $ 63,909 -------- -------- Total Liabilities and Stockholders' Equity...................$ 70,371 $ 64,934 ======== ========
Condensed Statements of Income >caption> Years Ended December 31, 1996 1995 1994 Income Dividends from subsidiaries...............$ 4,847 $ 3,837 $ 966 Dividends on investment securities........ 3 2 none Other income.............................. 1 1 1 -------- -------- -------- Total Income............................ 4,851 3,840 967 -------- -------- -------- Expenses Other expense............................. 155 141 178 -------- -------- -------- Total Expenses.......................... 155 141 178 -------- -------- -------- Income before income taxes and equity in undistributed net income of subsidiaries........................... 4,696 3,699 789 Income taxes (credits)...................... (51) (47) (60) -------- -------- -------- 4,747 3,746 849 Equity in undistributed income of subsidiaries.............................. 5,064 5,248 7,428 -------- -------- -------- Net Income..................................$ 9,811 $ 8,994 $ 8,277 ======== ======== ========
Statements of Cash Flows Years Ended December 31, 1996 1995 1994 Cash flows from operating activities Net income........................................$ 9,811 $ 8,994 $ 8,277 Adjustments to reconcile net income to net cash provided by/(used in) operating activities: Undistributed (earnings) loss of subsidiaries..... (5,064) (5,248) (7,428) Changes in operating assets and liabilities: (Increase) decrease in other assets............. 796 (519) (142) (Decrease) increase in other liabilities........ 164 142 73 -------- -------- -------- Net cash provided by/(used in) operating activities............................ 5,707 3,369 780 -------- -------- -------- Cash flows from investing activities Purchase of investment securities Available-for-sale.............................. (83) (81) none -------- -------- -------- Net cash provided by/(used in) investing activities...................................... (83) (81) none -------- -------- -------- Cash flows from financing activities Proceeds from issuance of common stock........... 239 1,731 2,645 Cash dividends paid.............................. (4,508) (5,260) (3,386) Cash dividends paid in lieu of fractional shares............................... (24) none none Acquisition of treasury stock.................... (547) (1,252) (379) Proceeds from issuance of treasury stock......... 320 1,207 241 -------- -------- -------- Net cash provided by/(used in) financing activities...................................... (4,520) (3,574) (879) -------- -------- -------- Increase (decrease) in cash....................... 1,104 (286) (99) Cash Beginning....................................... 5 291 390 -------- -------- -------- Ending.........................................$ 1,109 $ 5 $ 291 ========= ======== ========
Summary of Quarterly Financial Data (Unaudited) Sterling Financial Corporation and Subsidiaries The following is a summary of the quarterly results of operations for the years ended December 31, 1996 and 1995. Net income per share of common stock has been restated to retroactively reflect a 5% stock dividend paid in July 1996. 1996 Quarter Ended March June September December 31 30 30 31 Interest income..................$ 12,798 $ 13,013 $ 13,227 $ 13,520 Interest expense................. 5,465 5,635 5,832 5,891 --------- ------- -------- -------- Net interest income.............. 7,333 7,378 7,395 7,629 Provision for loan losses........ 159 102 50 269 --------- ------- -------- -------- Net interest income after provision for loan losses...... 7,174 7,276 7,345 7,360 Other income..................... 2,509 2,551 2,592 2,920 Other expenses................... 6,479 6,523 6,672 7,095 --------- -------- -------- -------- Income before income taxes....... 3,204 3,304 3,265 3,185 Applicable income taxes.......... 768 818 802 759 --------- -------- -------- -------- Net income.......................$ 2,436 $ 2,486 $ 2,463 $ 2,426 ========= ======== ======== ======== Net income per share of common stock...................$ .39 $ .40 $ .39 $ .39 1995 Quarter Ended March June September December 31 30 30 31 Interest income..................$ 11,536 $ 12,090 $ 12,509 $ 12,715 Interest expense................. 4,776 5,258 5,529 5,590 --------- ------- -------- -------- Net interest income.............. 6,760 6,832 6,980 7,125 Provision for loan losses........ 151 126 182 75 --------- ------- -------- -------- Net interest income after provision for loan losses...... 6,609 6,706 6,798 7,050 Other income..................... 1,905 1,964 2,127 2,297 Other expenses................... 5,687 5,809 5,809 6,118 --------- -------- -------- -------- Income before income taxes....... 2,827 2,861 3,116 3,229 Applicable income taxes.......... 696 718 794 831 --------- -------- -------- -------- Net income.......................$ 2,131 $ 2,143 $ 2,322 $ 2,398 ========= ======== ======== ======== Net income per share of common stock...................$ .34 $ .35 $ .37 $ .39 Item 9 - Changes in and Disagreements with Accountants on Accounting and Financial Disclosure None PART III Item 10 - Directors and Executive Officers of the Registrant Incorporated by reference is the information appearing under the headings "Information about Nominees and Continuing Directors" and "Officers and Executive Officers" of the 1997 Annual Meeting Proxy Statement. Item 11 - Executive Compensation Incorporated by reference is the information under the headings "Compensation of Directors" and "Executive Compensation" of the 1997 Annual Meeting Proxy Statement. Item 12 - Security Ownership of Certain Beneficial Owners and Management Incorporated by reference is the information appearing under the headings "Principal Holders" and "Beneficial Ownership of Executive Officers, Directors and Nominees" of the 1997 Annual Meeting Proxy Statement. Item 13 - Certain Relationships and Related Transactions Incorporated by reference is the information appearing under the heading "Transactions with Directors and Executive Officers" of the 1997 Annual Meeting Proxy Statement and under "Notes to Consolidated Financial Statements - Note 17 - Related Party Transactions" on page 59 of this Form 10-K. PART IV Item 14 - Exhibits, Financial Statement Schedules and Reports of Form 8-K (a) The following documents are filed as part of this report: 1. The financial statements listed on the index set forth in Item 8 of this Annual Report on Form 10-K are filed as part of this Annual Report. 2. Financial Statement Schedules All schedules are omitted because they are either not applicable, the data are not significant or the required information is shown in the financial statements or the notes thereto or elsewhere herein. 3. Exhibits The following is a list of the Exhibits required by Item 601 of Regulation S-K and are incorporated by reference herein or annexed to this Annual Report. 3(i) Amended Articles of Incorporation of Sterling Financial Corporation. (Incorporated by reference to Exhibit 3(i) of the Current Report on Form 8-K, filed with the Securities and Exchange Commission, on June 14, 1996.) 3(ii) Amended Bylaws of Sterling Financial Corporation. (Incorporated by reference to Exhibit 3(ii) of the Current Report on Form 8-K, filed with the Securities and Exchange Commission, on March 7, 1996.) 10a Employment Agreement, dated as of April 30, 1983, between The First National Bank of Lancaster County and John E. Stefan. (Incorporated by reference to Exhibit 10a of the Current Report on Form 8-K, filed with the Securities and Exchange Commission, on March 19, 1997. 10b Assumption and Modification Agreeement, dated July 14, 1987, by and among John E. Stefan, Bank of Lancaster County, N.A. and Sterling Financial Corporation. (Incorporated by reference to Exhibit 10b of the Current Report on Form 8-K, filed with the Securities and Exchange Commission, on March 19, 1997.) 10c Sterling Financial Corporation 1996 Stock Incentive Plan. (Incorporated by refernce to Exhibit 99 of the Current Report on Form 8-K, filed with the Securities and Exchange Commission, on February 5, 1997.) 10d The Sterling Financial Corporation Dividend Reinvestment and Stock Purchase Plan. (Incorporated by reference to Exhibit A to the Prospectus included in the Registration Statement No. 33- 55131 on Form S-3, filed with the Securities and Exchange Commission on August 18, 1994.) 11 Statement re: Computations of Earnings Per Share (included herein at Item 8 at Notes to Consolidated Financial Statements, Note 2.) 21 Subsidiaries of the Registrant 23 Consent of Auditors 27 Financial Data Schedule (b) Reports on Form 8-K A report on Form 8-K dated November 19, 1996 was filed November 29, 1996 pursuant to item 5 of Form 8-K reporting the adoption of the 1996 Stock Incentive Plan. The Plan will be submitted for approval at the 1997 Annual Meeting of Shareholders. Signatures Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. STERLING FINANCIAL CORPORATION By: John E. Stefan Chairman of the Board, President and Chief Executive Officer Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities indicated. Signature Title Date Chairman of the Board, /s/ John E. Stefan President and Chief February 25, 1997 (John E. Stefan) Executive Officer; Director /s/Jere L. Obetz Senior Vice President/ February 25, 1997 (Jere L. Obetz) Treasurer,Chief Financial Officer /s/Ronald L. Bowman Vice President/Secretary, February 25, 1997 (Ronald L. Bowman) Principal Accounting Officer Director February 25, 1997 (Richard H. Albright, Jr.) /s/Robert H. Caldwell Director February 25, 1997 (Robert H. Caldwell) /s/Howard E. Groff, Jr. Director February 25, 1997 (Howard E. Groff, Jr.) /s/Joan R. Henderson Director February 25, 1997 (Joan R. Henderson) /s/J. Robert Hess Director February 25, 1997 (J. Robert Hess) Director February 25, 1997 (Calvin G. High) /s/J. Roger Moyer, Jr. Director February 25, 1997 (J. Roger Moyer, Jr.) /s/E. Glenn Nauman Director February 25, 1997 (E. Glenn Nauman) /s/Glenn R. Walz Director February 25, 1997 (Glenn R. Walz) EXHIBIT 21 SUBSIDIARIES OF THE REGISTRANT The following are the subsidiaries of Sterling Financial Corporation: Subsidiary State of Incorporation or Organization Bank of Lancaster County, N.A. Pennsylvania 1 East Main Street (National Banking Association) P.O. Box 0300 Strasburg, PA 17579 Town & Country, Inc. (Wholly owned Pennsylvania Subsidiary of Bank of Lancaster County, N.A.) 1097 Commercial Avenue East Petersburg, PA 17520-0038 Sterling Mortgage Services, Inc. Pennsylvania (Presently inactive) 101 North Pointe Boulevard Lancaster, PA 17601-4133 Trout, Ebersole & Groff, LLP Certified Public Accountants 1705 Oregon Pike Lancaster, Pennsylvania 17061 Exhibit 23 Consent of Independent Certified Public Accountants We hereby consent to the incorporation by reference in Registration Statement No. 33-55131 on Form S-3 filed August 19, 1994 of our opinion dated January 24, 1997, on the consolidated financial statements of Sterling Financial Corporation for the year ended December 31, 1996 as set forth in this form 10-K. /s/ Trout, Ebersole & Groff, LLP Trout, Ebersole & Groff, LLP Certified Public Accountants Lancaster, Pennsylvania March 6, 1997 Exhibit Index Page Exhibits Required Pursuant to (in accordance with Item 601 of Regulation S-K sequential numbering system) 3(i). Amended Articles of Incorporation of Sterling Financial Corporation. (Incorporated by reference to Exhibit 3(i) of the Current Report on Form 8-K, filed with the Securities and Exchange Commission, on June 14, 1996.) 3(ii). Amended Bylaws of Sterling Financial Corporation (incorporated by reference to Exhibit 3(ii) of the Current Report on Form 8-K, filed with the Securities and Exchange Commission, March 7, 1996.) 10a Employment Agreement, dated as of April 30, 1983, between The First National Bank of Lancaster County and John E. Stefan. (Incorporated by reference to Exhibit 10a of the Current Report on Form 8-K, filed with the Securities and Exchange Commission, on March 19, 1997. 10b Assumption and Modification Agreeement, dated July 14, 1987, by and among John E. Stefan, Bank of Lancaster County, N.A. and Sterling Financial Corporation. (Incorporated by reference to Exhibit 10b of the Current Report on Form 8-K, filed with the Securities and Exchange Commission, on March 19, 1997.) 10c Sterling Financial Corporation 1996 Stock Incentive Plan. (Incorporated by refernce to Exhibit 99 of the Current Report on Form 8-K, filed with the Securities and Exchange Commission, on February 5, 1997.) 10d The Sterling Financial Corporation Dividend Reinvestment and Stock Purchase Plan (Incorporated by reference to Exhibit A to the Prospectus included in the Registration Statement No. 33- 55131 on Form S-3, filed with the Securities and Exchange Commission on August 18, 1994.) 11 Statement re: Computations of Earnings Per Share (included herein at Item 8 at Notes to Consolidated Financial Statements, Note 2.) 21 List of Subsidiaries 68 23 Consent of Auditors 69 27 Financial Data Schedule EX-27 2
9 12-MOS DEC-31-1996 DEC-31-1996 31339 644 24150 0 79375 94222 94778 474848 7800 764072 647036 2741 14682 30434 31185 0 0 37994 764072 41611 10947 0 52558 20709 22823 29735 580 158 26769 12958 12958 0 0 9811 1.57 1.57 4.86 1193 737 0 0 7780 703 143 7800 7800 0 3114
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